Professor Richard Thaler won this year’s Nobel Prize for Economics, in part, for research confirming that we (humans) believe we are smarter and more rational than we actually are. Asked how he plans to spend the $1.1 million prize money, Thaler replied, “I will try to spend it as irrationally as possible.” [Should he call, please let him know I stand ready to help.]
Reading Thaler’s research raises issues relevant to investing in timberland and forest industry stocks. We may believe we have superior insight into the value of an asset or the wisdom of a strategy, and that this belief in our own insight – as opposed to subjecting the insight to a suitable gauntlet of tests – gives license to act and a means to profit. This encourages us to overweight our assessment of values and market plays, while discounting the reality that hundreds or thousands of other (humans) are looking at the same data at the same time and coming to similar conclusions.
When too much capital chases too few assets, it creates its own momentum. And this momentum of the institutional conscious can lead to overvaluing assets. So when we prophylactically ask whether timberland is priced above or below its intrinsic values, we should assume the icy logic and rationality of Dr. Spock and look to the math.
From NCREIF data on institutional timberland investments:
- In mid-1997, timberland values averaged $1,001 per acre, with 1-year total returns of 14.2%.
- About 7.1% from appreciation and 7.1% from income.
- In mid-2007, timberland values averaged $1,500 per acre, with 1-year total returns of 11.5%.
- About 3.8% from appreciation and 7.7% from income.
- As of mid-2017, timberland values average $1,823 per acre, with 1-year returns of 3.3%.
- About 0.7% from appreciation and 2.6% from income.
What can we expect from timberlands for future returns? Logic and data indicate that, at best, we can expect modest returns. The multiple between values and total returns moved from about 7 to 13 to over fifty. While this snapshot provides an incomplete story, it affirms that we pay significantly higher prices today for each unit of expected returns in the future.
If timberlands are historically expensive, it reminds us that investing relies on relative performance and differing objectives. U.S. 30-year government bonds, a “riskless” alternative, yield 2.9%. Low interest rates, in part, reflect a low demand for money and higher demand for savings and investment. Timberland, like bonds, provides a way to preserve wealth and store value. Which makes us consider risk and things to worry about.
For timberland, I worry less about regional or asset class-specific values and much more about individual properties and local timber markets. Timberland price-to-value metrics depend critically on the local wood basin and forest stocking level of the given property. For example, over the past four years, key changes in valuation drivers include (1) the continued accumulation of forest supplies in the South and (2) the role of technology and efficiency at wood using mills. In addition, values depend highly on the selection and application of an appropriate discount rate.
Meanwhile, avoid irrational rationalization with your timberlands. Focus on responsible forest management, attentive relationships with timber markets, and opportunistic buying and selling of adjacent timberlands.
Forisk will teach “Wood Flows & Cash Flows” in Atlanta on December 7th, a one-day event that reviews and applies research and analysis to investments and forecasts across the forest industry supply chain, from timberlands to mills owned privately and by publicly traded firms.
One of your better gems, Brooks, on a number of scores. (1) Those of us who attempt to forecast prices and returns (i.e., all of us) speak so authoritatively about “how it’s gonna be”, and then are rudely reminded that the future is unknowable; (2) In developed markets, such as ours, results are all local, so an understanding of the minutiae of local conditions is essential. “Opportunistic” is not a pejorative term. Forest managers will play the larger role going forward. Thanks for reminding us of the obvious.
Jim: thank you for reading and commenting. Agreed! Tighter markets increase the value of and need for local forest management expertise.
I read your columns for the humor, and then I hope to gain some knowledge. Thanks for both. The only thing I have to add to this valuation discussion is that I have kept my land as an “alternative” investment. I have noticed in those dramatic stock market downturns that my “alternative” followed suit. Now, the return sucks, too! Its only saving grace is that it is real.
I really enjoyed reading this post! I am no expert on the topic but I guess that this will lead to consolidation of TIMOs and probably those that paid too much for too many of their properties will end up going through deep trouble in the coming decade. The fascinating part is that so many TIMOs keep quoting those mid-1997 returns and assumptions in their publications and outreach materials […]
An interesting post. Yes, look to the math . . . although I am not sure that “earnings multiples” represent the math of choice when trying to value timberland, or any real asset. It is interesting that if Dr. Spock, using his icy logic were asked to opine on current (or near future term) private placement timberland returns that he would end up about where they are at the moment. Take any one of the published asset pricing models for private placement timberland (make it easy and use CAPM) and predict the return for 2017. Let’s assume a slightly negative beta (-0.1), a risk-free rate of 1.42% (current one year T-bill rate), and a market risk premium of 11% (seems reasonable given current market performance). This provides an expected return of 0.32% – pretty consistent with recent returns in US Timberland. Remember, timberland is generally used to diversify a portfolio. The situation, at least according to the asset pricing Dr. Spock’s out there is where timberland will perform below “expected levels” (say 5 to 6 percent) is an economic world with little inflation and a robust equities market. Just where we are at the moment. An interesting question might be . . . as this current economic climate changes (higher inflation and an equities market that might be a bit more bearish – one possible scenario) do you want some timberland exposure? I’ll leave that to the Dr. Spock’s of the timberland world to decide.
One last thought here is that many financial economists might argue that current rates for borrowing (or saving) have little or nothing to do with the concept of supply and demand and a functioning financial market, but are controlled by central bankers wishing to insure a chicken in every pot. Personally, I still subscribe to Dr. Fama’s views on markets – the current Nobel Prize not withstanding.
[…] here for a longer post that applies this thinking to timberland […]