Institutional investors worldwide own approximately $60 billion worth of timberland, of which two thirds ($40 billion) is invested in the U.S., nevertheless, the principal owners of timberland are private, non-industrial landowners, with about $150 billion.
Some investors classify timberland investments as private equity, as many of the commercial timberland deals have been made through private equity investment structures and managed by a timberland investment management organization (TIMO).
Some investors consider timberland a specialized form of long-term fixed income, as it generates cash each year through harvest and sale of timber.
Some may also view timberland as real property/real estate. The difference is that traditional commercial real estate investments realize income primarily from leasing, while timberland derives its income from periodic timber sales, recreation, and value added. In addition, the source of return of timberland investments also comes from land appreciation and biological growth.
The cash basis return of timberland investments is the total of income (timber sales, recreation, and value added), land appreciation, and biological growth of timber assets.
Performance (as represented by NCREIF Timber Index)
- As of 8/31/2012, the NCREIF Timber Index had an annualized return of 7.6%, while the S&P 500 Index posted 6.5% for the last 10-year period; in the latest 20 years, NCREIF Timber achieved 9.7%, compared to 8.4% that of S&P 500.
- In calendar year 2008, the NCREIF Timber returned 9.5%, however, the S&P 500 dropped 37%.
- The 10-year Sharpe ratio for the NCREIF Timber is 0.91, but that of S&P 500 index is only 0.37. Timberland investments have a potential for more competitive returns relative to its risk profiles.
- Timberland as an asset class has a negative correlation to the broad U.S. equity market, low correlation to global fixed income, and positive correlation to inflation. It hedges against inflation.
Benefits of Timberland Investments
- The U.S. timberland investments have delivered superior returns over the past decades relative to its risk profile.
- The calendar year 2008 performance (see above) also proves that private timber offers goo downside protection.
- Timber as an asset class offers a level of price stability over the long-term.
- Timber’s biological and investment growth cycles are steady and predictable.
- The total return can be enhanced by the biological growth of the timber, product class jumps, and active management.
- Timberland investments have the versatility to be shaped, and the portfolios can be structured to meet different investment objectives. A few examples: 1) higher cash flows can be achieved by including a higher proportion of more mature timber holdings; 2) young pine plantations with high growth rates can be considered for acquisition if long-term gains are more important than regular cash flow; 3) various timber age classes may be included if an investor’s goal is a balance of intermittent cash flows with an emphasis on long-term appreciation.
- Historically, demand for wood products has tracked closely with worldwide population growth; the rapid growth of investment in timberland among U.S. institutional investors will ultimately push the price of timberland higher as buyers compete for available land.
- The correlation profile of Timberland to other major asset classes (please see above) indicates that it offers great diversification benefit, and hedges against inflation and market downturns.
- Timber is a renewable, natural resource that provides ecosystems with clean air, water, wildlife habitat, and carbon sequestration.
- For individual investors, timberland ownership offers tax advantages where income from timberland can generally be treated as capital gains.
Potential Risks of Timberland Investments
- Physical risks can vary by region and generally include events such as fire, tornado, hurricane, and forest pests.
- Outside of the Western U.S., action from political and environmental groups has not traditionally been a major factor due to the large base of private timberland ownership.
- The demand for timber can be impacted by factors such as a decline in housing starts, substitution of other finished products and materials.
- Valuation risk in terms of site quality and land management
- Many areas with expansive timberland have few nearby production markets; overhead costs in transporting timber to mills negatively impact profits.
- Short-term price volatility, interest rate fluctuations, and lack of liquidity should also be considered.