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Does Timberland Have a Liquidity Problem?

This post includes excerpts from the Q2 2024 Forisk Research Quarterly (FRQ) feature article, “Topics on Forest Finance: Investment Criteria and Timberland Liquidity” and from the forthcoming 7th edition of Forest Finance Simplified.

Liquidity – the ability to convert assets into cash – generally worries investors, from institutions to hedge funds to individuals. In my research, I find that the issue of liquidity varies significantly by investor and over time, and that we are quick to generalize about the advantages and disadvantages of liquidity, especially in forestry. In the case of timberland, how can we frame liquidity in a way that provides context?

Issues Related to Timberlands and Liquidity

In finance, liquidity is a construct that affects certain folks in certain situations; it does not affect everyone always. Liquidity is a problem when you need it and don’t have it. With timberland, liquidity comprises a set of issues that may relate or overlap. For example:

  • Leverage: Debt differentiates during market crashes. While leverage has its role, timberland investors without debt cannot be compelled to liquidate during tough times with timber markets (though they may need to sell for non-timber obligations). For highly leveraged organizations, debt compresses time and reduces options.
  • Valuations: If we view liquidity as a balance of buyers and sellers at any time, then in the absence of buyers or sellers, what is an asset worth? When traders scramble to pay debts and meet margin calls, they don’t sell what they should, they sell what they can. Investors in comparable situations act surprised when markets tank and buyers are nowhere to be found. The best strategy: account for liquidity in advance.
  • Diversification: Part of what makes timberland attractive includes return characteristics that rely on some “independence” from the overall market, which we could call illiquidity. The “indifference” of timberland to other assets is part of what makes it diversifying. In practice, many assets are illiquid relative to cash, bonds, or equities. Cars and homes take weeks and months to buy or sell. While we can view this illiquidity as a constraint that limits short-term options, we can also see it as a protective moat that better preserves value (and wealth) for knowledgeable owners.

Planning Ahead to Manage Liquidity

At times, timberland investors need cash. For example, due to irregular harvest revenues – a normal case for smaller timberland ownerships – the investor may need supplementary funds at times through a partial sale or from another source. The scale, time horizons, and opportunism required to manage timberland affects its liquidity. Partnerships, REITs, and secondary markets aim to mitigate this.

The liquidity implications for timberlands are asset and investor specific. Situations comprise a balance of time versus flexibility. While it helps to plan how you might unload a timber tract in a crisis, you get part-way there by breaking down the forest into its salable components, including timber, hunting rights, and choice parcels. Each sizable timberland asset comprises a diversified portfolio of smaller assets. The issue of liquidity for timberland is rarely all or nothing.

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