Portfolio Risk Reduction Benefits

Since the boom in the late 1990’s and the bust in early 2000 of technology stocks, many investors recognize the need for portfolio diversification. Timberland has been negatively correlated to the stock and bond markets and provides excellent diversification within an individual’s real estate holdings. For instance during the period of 1989 to 1998, according to the National Council of Real Estate Investment Fiduciaries, timberland returns were 14.5%, real estate was 5.3%, and stocks returned 19.1%.

Timberland has a risk reduction benefit when added to a portfolio. The returns on a timberland investment have a low volatility when compared to an investment in equities. Investors generally expect a high rate of return to be associated with high risk. Forestry investment risk is low on well-managed land and offers a rate of return comparable to higher risk investments.

The combination of timberland investments with common stocks results in a decreased risk due to the lack of correlation between the two.  This type of asset combination can enhance portfolio returns during times of poor stock and bond performance. The Standard and Poor's average of 500 common stocks and the National Council of Real Estate Investment Fiduciaries southern timber index are frequently negatively correlated. When the rate of return from timberland increases, the rate of return from stocks decreases.

Rate of Return

Timberland provides competitive real returns depending on timber and property characteristics. Returns in timberland are influenced by three factors:

1. Biological Tree Growth
2. Timber Price Increases
3. Changes in the Value of the Underlying Land Asset.

Biological Growth

Biological growth is a unique characteristic of timberland. In a southern pine stand that is young and well-managed one should see a 5-7% increase in volume annually. This increase is independent of economic or financial market conditions. Biological growth is the factor that maintains timber returns in times of falling prices. There is an additional price increase, which arises when trees grow into sizes from which more valuable products are made. This is an “ingrowth” of product classes where there is more value per unit of volume. For instance, in the fourth quarter 2005, according to Timber Mart-South, pine sawtimber stumpage averaged $39.53/ton south wide and pine pulpwood averaged $7.10/ton southwide. Ideally it is best to purchase premerchantable timber between the ages of ten and fifteen. Buying this age class of timber allows the investor to take advantage of the “ingrowth” characteristics of timberland. By the time a stand is 25 to 30 years old the products growing in the forest will be primarily chip-n-saw and sawtimber. A thirty-year-old well-managed stand can yield $4,000 to $6,000 per acre.

Risks such as fire, insects, or storm damage have had relatively little impact. Averaged over many tracts and many years, physical losses will exceed normal mortality by only about 0.5% to 1% of volume per year. Growth usually more than offsets this loss and dead and dying wood can often be salvaged. Market risk is that timber prices will be low at the time you wish to harvest. Timber investors have the advantage of waiting until markets are favorable. Timber can be stored on the stump and it does not ripen like many other agricultural commodities.

Price Appreciation

Changes in timber prices are influenced by a number of macroeconomic factors including interest rates, housing starts, and the overall level of economic activity. Variables at the microeconomic level such as locations of mills and amount of wet weather also affect timber prices.; Price inflation also contributes to the real returns seen from timber. As supplies decrease and demand increases, prices are expected to continue increasing in real terms. For example, from 1990 to 2001 pine sawtimber is up 107% and Chip-n-saw prices are 98% higher. Pulpwood has not increased at the same rate, while hardwood sawtimber increased at 130% since 1990.

Land Value

Variation in land value is mostly affected by location and land quality. Land prices generally increase with the rate of inflation. This slow increase of land values tends to "buffer" timber returns. However, on select tracts, land values can greatly increase the rate of return through the potential for development such as with locations in close proximity to Atlanta. Timberland returns can also be increased through the use of recreational leases.

Liquidity

Timberland investments are best suited for the long-term investors. Large tracts can take several months to sell because the acquisition cost can be fairly high. This sort of investment requires a long-term outlook and returns can be stronger if held for a long period of time.

Protection from Inflation

Investments with values tied to real assets such as land, factories and artwork are less susceptible to inflationary risk. Since timberland is a real asset, it can provide protection from inflation. Studies have shown that stumpage values in the United States have at least kept up with the rate of inflation. Timberland investment is a variable income investment meaning that its income and value tend to rise with inflation. Money invested in fixed dollar assets such as treasury bills, bonds and savings accounts are susceptible to inflationary risk, but during times of deflation are considered to be safer than investments in real assets. Studies have shown that investment in timberland in the South has been an effective hedge against inflation. This means that when southern timberland is combined with typical financial assets such as stocks and bonds the portfolio is less sensitive to inflationary surprises. This is why many astute investors view timberland as a good diversification.

Southeast

The southern United States contains 41% of the country's productive timberland and, according to the U.S. Forest Service, provides 53% of the nation's softwood and 59% of the hardwood. Timber supply is a major factor when looking at timber investments. The United States Forest Service inventories the nation's forests every ten years and projects the nations timber supply. It is possible to predict what the domestic timber supply will be for the next 20-30 years because it takes that long to grow trees. The Forest Service has predicted that southern timber prices will increase well into the 21st century. This is because 73% of the land in the South is owned by non-industrial private landowners and on these lands, removals are exceeding growth and this trend is expected to continue into the 21st century.

Demand for lumber and paper products will continue to increase while every year the U.S. loses more productive timberland to urban sprawl, restrictive timber harvests as in the Pacific Northwest, and because many landowners are not replanting post harvest. All of these factors put more pressure on a smaller land base and will cause real price increases in southern timber for the foreseeable future, thus high returns for the southern timberland investor.