This post includes topics addressed in the Q1 2024 Forisk Research Quarterly (FRQ) and the (virtual) Applied Forest Finance course on March 14th, 2024.
Timberland markets remain extremely competitive as investors struggle to acquire assets. Quotes from Forisk conversations with timberland investors and TIMO executives over the past several months include:
- “The challenge remains placing capital. We get close, but not quite there.”
- “We are close, but not able to win any deals.”
- “Some investors…have actually reduced their discount rates.”
Analysis from MetLife Investment Management (MIM) in December 2023 supported the observation on timberland discount rates: “Despite the rapid rise in interest rates, the average U.S. timberland discount rate in MIM’s debt portfolio decreased by approximately 34 basis points since 2019.”
To find an edge, timberland investors are deploying multi-part valuation models and working to leverage carbon markets, solar deals, and real estate. Tracking of transactions highlights a combination of low discount rates relative to rising interest rates, buoyant projections and expectations for forest carbon markets, and aggressive assumptions associated with land appreciation.
That said, a portion of the market remains committed to the “forestry” fundamentals. One private timberland owner kept returning to the realities of distance and margins. “Look, the way we see it it’s all about mileage to the mill. If you’re farther away from the mill, your stumpage is worth less. It’s that simple.”
Traditional Drivers of Timberland Returns
When investing in timberland, the price paid crucially affects the ultimate profitability of the investment. Outside of acquisition price, timberland investment returns are largely a function of (1) biological tree growth; (2) timber price changes; and (3) land value appreciation. The extent to which each of these drive returns from a given tract depends in part on the geographic region and the specific location of the timberland relative to wood-using mills and population centers. Location matters.
Biological growth, which includes (1) increases in volume and weight and (2) enhanced value from a tree growing from a lower-priced product to a higher-priced one, remains an important part of the timberland investment calculus. It offers the most basic form of “optionality” as larger diameter trees can be used for wider range of mostly higher-valued end products.
Active forest management, once an innovative strategy, is now an operational requirement for timberland investment success. Active management includes leveraging all available cash flows from recreation and hunting and new markets such as carbon and solar, in addition to increasing forest productivity from improved seedlings and intensive silvicultural treatments. Productive forests support higher cash flows and values.
Timberland Investment Vehicles
Investors have three basic ways to add timberland to their portfolios, not including those available through debt markets (e.g. making loans or buying bonds in timberland-owning companies).
First, investors can directly acquire and manage timberlands. With this approach, investors enjoy the full diversification, wealth preservation, and cash flow benefits of owning trees. Ownership also requires the capital and ongoing commitment of having or hiring and maintaining the forestry and operational expertise required to optimize and manage the assets.
Second, investors can outsource by providing funds to a timberland investment specialist to acquire and manage timberland investments on their behalf. Institutional investors, for example, will work with a timberland investment management organization (TIMO). Within this approach, investors have options with respect to the nature and structure of the fund. This ranges from employing a single-investor separate account to participating in a commingled fund with other investors to joining a “fund-of-funds” that pools capital for use in a set of commingled funds managed by different TIMOs.
Third, investors can “go public” and acquire shares in traded timberland-owning real estate investment trusts (timber REITs). The most liquid of the three described investment approaches, the currently available timber REITs include Weyerhaeuser (WY), Rayonier (RYN), and PotlatchDeltic (PCH).
The quote about mileage and distance to the mill cannot be overstated. With the increases in trucking costs from wages, equipment, fuel, and insurance, the cost of trucking has almost doubled in less than a decade. Mileage matters, and even a difference of 10 miles from a mill has the ability to change the price on the stump for a landowner from 5-20% per ton depending on the product.