One challenge of investing in a forest is determining when it reaches financial maturity. This is when the owner’s cost of keeping an asset exceeds expected returns. Timber complicates this thinking because a tree is both the “product” and the “factory,” which continues to appreciate over time through adding volume and value. Harvesting trees resets the production process. So we approximate financial maturity in forestry by comparing the annual increase in forest value with the investor’s expected rate of return from other investments of similar risk and duration.
A forest’s value can be well established at two points in time: at the start and at the end of the rotation. At the start, establishment (site preparation and planting) costs are easily known and quantified. At the end, forest values reflect future timber revenues. We rely on two discounted cash flow (DCF) techniques to assist us: compounding investment inputs to estimate future values, and discounting anticipated future returns to estimate present values.
Financial analysis often supports the “investment decision” by helping investors rank investment options, evaluate investment risk, and assess the impact of a given investment or project on the forest. For example, marginal analysis helps assess forest management and intermediate harvest decisions for existing stands. It answers questions of “when to harvest?” and “when does forest management pay?” Incremental differences in costs and benefits “on the margin” clarify decision making by focusing on the effects of a specific treatment or harvest decision, not on the entire portfolio or investment.
Click here to learn about and register for “Applied Forest Finance” on March 29th in Atlanta, Georgia. The course details necessary skills and common errors associated with the financial analysis of timberland and other forestry-related investments.