Simple reasons explain how and why timberland assets attract investors:
- Safety: timberland preserves capital.
- Growth: trees grow and land appreciates.
- Diversification: timberland behaves differently than stocks, bonds and stamp collections.
The actual investing in and managing of timberland requires discipline, patience and a sharp pencil. Big jobs, done well, take time. And successful timberland investing and management take time. How can any forester plant and manage well a forest quickly? How can we expect strong relationships with local markets? How can we expect deep understanding of how and why our forest prospered or failed, and how to deal with the small, unavoidable challenges of owning and analyzing our forest investments in turbulent times?
This checklist provides a working set of priorities for minimizing errors, mitigating risks and maximizing potential returns.
- Specify objectives. This is harder than it sounds. Goals must be simple, clearly defined and prioritized. Forest investing awards no bonus points for degrees of difficulty. Forest investments are sexy because they simply (not ‘easily’) provide a long-term option to protect, hold and increase wealth. Multi-headed, competing objectives undermine valuation modeling and forest management.
- Question forest data and financial analysis. In forestry, everything is a sample. A forest cruise is a sample of the standing inventory. Timber pricing services report a sample of prices from market transactions. Ask questions about the data and the assumptions in any price forecasts and financial analysis. Confirm discount rates, nominal and real pricing and the suitability of the financial metrics. How do the results square with history, logic, market tolerances and the time/space continuum as you understand it?
- Think like a business owner prior to making any investment. This differs from questioning the data and analysis; this tests the business strategy, investment thesis and financing structure. Talk through the plan in detail before moving forward. Take no chances in losing capital or tying it up in odd investment structures with limited options for recovery. Save gambling for the riverboat.
- Understand the local wood market when reviewing a timberland property. Timber markets are uniquely local. The same property in two different baskets will have two different values. Understand why. This goes beyond knowing the outlets into which you might sell logs. Know in advance how you or your manager will access these markets. Will you work through a forestry consultant? If so, who? How will you manage access and local relationships?
- Understand the ‘true’ risks and protect accordingly. Have a risk management plan and reasonable levels of insurance as required by law and helpful to long-term security. Timberland novices ask about fire, bugs, disease and hurricanes. Forest investment professionals can put these risks into perspective. They will tell you to worry more about markets, communicate with your forest manager and properly insure against landowner liabilities.
- Understand taxes and tax exposures. You can make a lot of money and lose a lot of money based on what you know or don’t know about timber taxes that apply specifically to you or your institution for each property by state and county.
- Watch expenses. In chemistry, we learn that a gas expands to take the shape of its container. And so it is with expenses, which can grow in proportion with or beyond our incomes. Don’t confuse “necessity” with “desire.” Make a budget and manage against it. Understand your cash flows, management fees and exactly who pays for what.
In the end, be brave and face facts. Will this timberland investment really generate 9% annual returns? How? Under what conditions? Do we really care about diversification, or have we deployed the word to make us feel better? If we do care about diversification, then it does have value and we should put a number on it. The investing process includes both the asking of questions and the getting of answers. These two different tasks help clarify assumptions, confirm competence and increase the likelihood of investment success.
Click here to learn about “Applied Forest Finance” on February 3rd in Atlanta, Georgia. The course details necessary skills and common errors associated with the financial analysis of timberland and other forestry-related investments.