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Why Timberland?
Every American goes through a 100-foot tree every year.
How, you ask? Just look around you… Chances are that you're sitting at a desk
made of wood, littered with paper reports, inside a room with wood trim and/or a
house that was framed in wood.
The commodity makes for big business. So if you've never considered investing in
timber as an investment strategy, perhaps you should.
Over the past two decades, some of the world's most prominent investors and
institutions – pension funds, endowments and insurance companies – have plowed
$40 billion into this asset class… up from just $1 billion in 1989.
Timber has been one of the consistent favorite investments of legendary investor
Jeremy Grantham. He points to how it's risen 3% more than inflation for more
than 90 years. During the next several years, he expects timber to have an
inflation-adjusted return of 6%.
The fact is that timberland has actually beaten the stock market over the long
run and with less risk. It has outperformed the S&P 500 over the last 100 years
since 1910. And since 1987, the NCREIF Timberland Index climbed by an average of
15% per year, compared to about 11% for the S&P 500.
The returns on timber are especially good in bear markets…
During the Great Depression, for example, timber gained 233% while the price of
stocks fell more than 70%. In fact, during the three worst market downturns of
the 20th century
(1911-20, 1929-41 and 1966-81), timber outperformed the S&P 500 by a wide
margin.
More recently, when the S&P tanked by 38% in 2008, timberland rose by 9.5% based
on the NCREIF Timberland Index.
You see, trees grow come rain or shine/ And so does their value… by an average
of 2% – 8% per year. It might not be a glamorous business, but it definitely is
a profitable one… in more ways than one.
Timber is also a natural inflation hedge. Real prices for timberland have risen
steadily for over 100 years. And during the last bout of high inflation in the
U.S. (1973-1981), it was a fabulous hedge, increasing by an average of 22% per
year.
Timber is also a fabulous portfolio diversification tool. It sports a very low
correlation with most asset classes of less than 0.1. So adding it to your
portfolio enhances the potential for return while reducing your risk at the same
time.
The Future for Timber
Let's take a look at the demand for timber. The United Nations forecasts that
world demand for wood will nearly double by the middle of the century.
Not surprisingly, that's in large part to China, which ranks second only to the
U.S. in wood consumption. It's also the #1 importer of timber products in the
world. In fact, more than half of the timber shipped anywhere in the world is
destined for China, which happens to be about 50% of the country's supplies.
China used to import large amounts from Russia, but it now derives the majority
of its supplies from New Zealand and western areas of North America. To show
just how important the latter area has become to China, look at shipments from
just the Canadian province of British Columbia, which increased 4-fold
year-on-year from January 2009 to January 2010. And annual shipments from
British Columbia have tripled since 2007 to $365 million.
For Canada as a whole, wood exports to China and the rest of Asia accounted for
23% of all exports in last year's fourth quarter versus only 13% in 2008, and 7%
five years ago.
If you’re not following the money into timberland, you should. Here’s why…
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Timberland has outperformed the S&P 500 since 1910.
In recent history, timber has outperformed the market significantly. Since
1987, the NCREIF Timberland Index climbed by an average of 15% per year,
compared to roughly 11% for the S&P 500.
Such strong outperformance boils down to one factor – biology.
Biology accounts for 65% to 75% of timberland’s performance. Nothing can stop it
from adding to the value of timberland investments. Come rain or shine, trees
grow. And so does their value. By an average of 2% to 8% per year, in fact.
Not even natural disasters can undermine timberland’s value, because companies
can still sell damaged timber. For example, after Mount St. Helens erupted,
nearly 80% of the scorched timber was still suitable for sale.
Investing In Timberland Is Better Than Stocks?
Although trees hardly lend themselves to compelling conversation, fact is, they
are a better investment than stocks. From 1973 to 2003, managed timber returned
15% per year. Meanwhile, stocks returned about 11%.
Even better, timber did so with considerably less risk. Case in point: in the
last 45 years, timber investments were down only three times. In comparison,
stocks slumped 12 times.
There’s a simple fundamental driving this out-performance. No matter what’s
going on in the world or the markets, trees keep growing, silent and unattended.
And so does their value.
The average North American forest produces about 8% more timber every year.
Plus, as the trees get larger, they command premium prices. Put simply,
timberland is a no-cost factory. And when selling conditions are soft, it also
functions as a warehouse, as the product can be “stored on the stump.”
Given this backdrop, why isn’t everyone rushing to own timber? They are just not
on the public markets.
Who Owns Timberland and Why?
The majority of timberland (71%) is privately owned. And most active investments
are facilitated through TIMOs (timberland investment management organizations).
TIMOs cater to the “smart money” – institutional investors such as the Harvard
Endowment, CALPERs and anyone else that can afford the stiff $5 million entry
fee. In recent decades, this “smart money” has been quietly piling into the
woods…
Right now, they have approximately $20 billion invested
in timberland.
That seems modest, until you realize as recent as 1989, this level stood at $1
billion.
Rest assured, these institutions aren’t simply chasing performance. They’re
attracted to timberland for two equally important reasons:
1. Like other commodities, timberland provides a natural hedge against
inflation. Research indicates that real prices for timber have steadily risen
for more than 100 years.
2. Timberland sports a low correlation with most major asset classes.
Accordingly, adding timberland to a well-diversified portfolio enhances the
return potential, while reducing risk (volatility).
It’s the second point that makes timberland a timely investment. Should the
stock and bond markets slump, timberland should perform well. And this time
around, the out-performance could be significant.
According to Investing Legend Jeremy Grantham, Timber Beats Stocks
Historically, timber has performed incredibly well. According to legendary
investor Jeremy Grantham, timber
prices have beaten inflation by 3.3% a year over the last century.
Add in 6% a year in income (from cutting trees), and 2.5% a year in inflation,
and you’ve got returns of nearly 12% a year in timber that beats the return on
stocks! Even
better, the returns on timber have been less volatile than the stock market.
Right now, it seems, just about every asset is overpriced. Stocks at a P/E of 30
are way too expensive to buy. Bonds that pay 4% interest aren’t exciting, and
neither is 1% on cash in the bank. The price of gold and many other commodities
has risen by 50% and more in recent years.
Timber is the odd man out. Timberland values actually fell in 2000, 2001, and
2002. As timber has been a good asset to own over the long run, the last few
years have been the worst few years anyone can remember.
“Perfect!” I say you see, the trees have kept growing and gaining value all this
time. Today we’re coming off the worst stretch of timber returns in many years.
Pessimism in the industry is high. But in the midst of pessimism, lumber prices
have been in a strong uptrend. It’s
my recipe for success a cheap asset, with great skepticism surrounding it in a
powerful uptrend. Time to buy!
Even Better News: Timber Performs Well When Stocks Perform Poorly
The last great bear market in stocks began in the late 1960s and lasted until
about 1980. An investor in stocks during that time literally lost money, due to
inflation. However, as the table below shows, an
investor in timber never had a losing year More often than not, the returns were
in the double digits with a 55% return in 1973 and a 47% return in 1977.
RETURNS PER YEAR:
Year Stocks Timber
1966 10% 13%
1967 24% 11%
1968 11% 18%
1969 -8% 22%
1970 4% 1%
1971 14% 4%
1972 19% 11%
1973 -15% 55%
1974 -26% 21%
1975 37% 1%
1976 24% 16%
1977 -7% 47%
1978 7% 29%
1979 19% 31%
The 1970s weren’t a “timber fluke.” Even in recent decades, timber has been one
of the best assets to own. The annual compound gain over the last few decades in
timber has been about 16%.
WHY INVEST IN TIMBERLAND?
A timberland investment is one whose primary source of return is derived
from the growth and harvest of timber. As an asset class, it offers
particularly attractive benefits to the long-term investor. They are:
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Timberland investments have historically
provided competitive returns relative to its risk profile. Such
returns hold up well against many traditional asset classes,
including stocks, bonds and real estate.
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Because of its unique nature, timberland often
performs differently from securities or other investment assets. As
such, it can offer an excellent opportunity for diversification when
added to a broad portfolio of investments.
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Timberland-a renewable and biologically
growing asset-represents an array of advantages among alternative
investments.
How are timberland investments characterized?
There are a variety of ways to approach timberland as an investment.
Some would classify it as private equity. An argument for this
classification could be made because many of the purchases of commercial
timberland for investment purposes have been made through private equity
investments structured and managed by a timberland investment management
organization (TIMO).
Another way to view timberland investment is a specialized form of
long-term bond. A forest that holds mature timber will generate cash
each year through the harvest and sale of timber. These harvests can be
modeled and forecasted with a reasonable degree of accuracy over many
years, even decades. Since timber growth and subsequent harvests are not
affected by the movement of financial markets, the forest investment
could be structured to act and behave in many respects like a long-term
bond.
Aside from private equity and fixed income, timberland is real property
and can be classified as an investment in real estate. While traditional
commercial real estate generates income from leasing, timberland derives
its income from the periodic sale of timber.
What is the invested universe of commercial timberland?
It is estimated that institutional investors globally now own about $35
billion worth of timberland. Of that amount, about $25 billion is
invested in the United States, which represents the world's largest
producer and user of timber products. Over the last 20 years, timberland
has emerged as a viable institutional asset class among almost 100
private pension, foundation, and endowment funds. Even with these
commitments, institutional owners own approximately 8% of the investable
timberland in the U.S. The principal owners of timberland are private,
non-industrial landowners ($150 billion). This large investable
timberland base represents continued opportunity for institutional
investors, particularly as private landowners and forest products
companies continue to sell off their timber holdings.
UNIQUE CHARACTERISTICS
Aside from offering competitive risk adjusted returns and portfolio
diversification, timberland is endowed with several unique
characteristics that institutional investors may find attractive. These
characteristics are (a) continued accretion of value due to the
biological growth of trees, (b) long-run adaptability to a range of
investor needs and circumstances, and (c) tax advantages for certain
individuals.
Benefit of biological growth
A unique advantage of timber is that as an asset it grows-quite
literally. Trees grow in volume, size, and ultimately into increasingly
higher-valued products. For example, in the US South individual trees
begin as lower-value pulpwood, grow into a combination pulpwood/sawtimber
tree (9 to 12 inches in diameter), normally referred in the timber trade
as "chip-and-saw", and then into sawtimber (trees that are generally
greater than 12 inches in diameter and of a high quality) for lumber
products. As a tree grows into these larger and higher product classes,
the monetary value of the tree increases as well. The negative impact of
the time value of money and the risk of negative returns can be offset
by the increasing volume and value of the asset. In short, the effect on
investment return by possible downward movement in timber prices is
mitigated by volume growth; the effect of upward price movement is
compounded by volume growth. In addition, over the life of the
investment, timber continues to grow although at a slower rate as trees
mature. This allows the investor to "warehouse" timber "on the stump,"
giving the investor greater opportunity to time the sale, or harvest
when prices are high and delay harvest when prices are low.
Timberland portfolio structuring to produce specific
investment objectives
Timberland investment portfolios can be structured to meet different
investment objectives. For example, higher cash flows can be achieved by
including a higher proportion of more mature timber holdings. If
long-term gains are more important than regular cash flow, then this
goal can be achieved by acquiring young pine plantations with high
growth rates and enhancing the benefits of biological growth through
intensive management techniques. If the investors' objective is a
balance of intermittent cash flows with an emphasis on long-term
appreciation, various timber age classes can be included in the
portfolio to achieve this goal. In addition, investment returns can be
improved with a variety of structuring and management options including
the use of leverage, selling selected properties that have real estate
development potential or recreational use value, or possibly using the
asset to support the issuance of asset-backed securities. In short,
timberland investments have the versatility to be shaped through
financial engineering to meet a variety of goals for the sophisticated
investor.
The tax advantage of timberland for individuals
For individual investors, timberland ownership offers tax advantages
where income from timber and timberland sales can generally be treated
as capital gains. In addition, there are specialized tax deductions and
credits that can be utilized for conservation easements, reforestation,
and timberland management practices.
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