In 1849, Martin Faustmann read an article about forest valuation and found it wanting. A German forester and appraiser, he developed and published an alternative technique for valuing bare forestland, or “dirt,” for tax purposes.  Faustmann’s approach, a special application of net present value (NPV), uses prices, costs and interest rates to determine the optimal economic forest rotation (age).  Faustmann’s formula – referred to as bare land value (BLV) or land expectation value (LEV) or soil expectation value (SEV) – remains a standard model for maximizing forest value in short and long-term analysis.

[Note: In the 1990 S. J. Hall Lecture in Industrial Forestry at U.C. Berkeley, John Walker identified Faustmann’s work as the “first known correct application of compound interest rates in discounted cash flow analyses.”   As a forestry professional, I take pride in thinking that a forester has such an important entrepreneurial place in the history of finance theory.]

What makes BLV useful for evaluating forestry investments?  BLV allows us to compare forestry investments of different rotation lengths. As such, BLV helps (1) identify the optimal rotation length for a forest; (2) order the management activities associated with a forest investment; and (3) determine whether or not to invest in specific silvicultural activities.  In addition, BLV helps us conduct marginal analysis on short-term harvesting decisions related to price “spikes” or declines in local markets.

BLV does rely on “strong” assumptions.  First, BLV assumes that costs and revenues for all future rotations remain identical.  Second, BLV assumes that the land will be reforested in perpetuity.  We don’t include a value for the land in the BLV math; rather, the BLV estimates the “bare land value” for us.  Third, BLV assumes that regeneration costs occur at the beginning of each rotation.

BLV provides a “theoretically” appropriate measure for valuing bare land managed exclusively for timber production; it represents the maximum you “would” pay to buy bare land at the beginning of a forest rotation and earn the target rate of return (represented by the discount rate) on the total investment.  In practice, the estimated BLV may not correspond to current market values for the land.  Investors may have alternative uses for the land, in which case the forestry-centric BLV may not be competitive.  Investors may also have different costs of capital (discount rates), which would produce different BLVs even with identical assumptions for initial costs and revenues.

Click here to learn about and register for “Applied Forest Finance” on February 10th in Atlanta, Georgia.  The course details necessary skills and common errors associated with the financial and risk analysis of timberland and other forestry-related investments.