Saturday, October 18, 2008

Valuing Timberland I

How much is that tract of timberland worth? Is it worth the asking price? Is fair market value for the tract a good investment? People have gotten rich buying timberland but rest assured that every purchase has not been a good investment! How the land is managed during ownership is important but it pales in comparison to smart purchasing and smart selling. This is the first in a series of posts that looks at how timberland is valued.

Here is a list of the key elements that should be considered when valuing timberland.

Disaggregation: The old expression “The whole is worth more than the sum of the parts” does not appear to be true. Valuing timberland typically begins by identifying the non-timberland values.


Inherent productivity of the land: foresters normally measure this by a quantitative metric referred to as site index.


Forest types and tree species: These are commonly confused but they are not the same thing.


Silviculture and productivity: Planted vs. natural. Fertilization, genetics, etc. What is impact on future yield (value)? Are records of past silvicultural practices available? Are they tied to a GIS?


Timber volumes: What does the cruise say? What does the inventory say? What is the difference? Are they tied to a GIS?


Timber values: What are the drivers? What are the sources of information? Should current market conditions be used for valuation? Or historical, or future estimates? What roles do harvesting costs and trucking costs play in timber value?


Reproduction values: On well managed land, reproduction values may exceed timber values. How do you estimate these values?


Cash flows: Revenue from timber sales, leases; silvicultural expenses, taxes, management fees.


Location: Important? Can it be quantified?


Final sale price: When you sell the land, how much will you get?


Discount rate: or how much of a return do I need to be competitive with investments with a similar risk?

Disaggregation: This first valuation post will address the issue of disaggregation or breaking the total value of the tract down into several components. Add up the value of the components and that’s the value – more or less. Early in my career (mid 1960’s) I was appraising and buying timberland in the Ohio Valley of West Virginia and Ohio. At that time, we cruised the timber and calculated the timber value, used a “table value” to estimate reproduction value (usually minimal or “0”), and assigned a modest “fixed” dollar/acre value for OGM (oil, gas and minerals) if they had not been previously conveyed. We then subtracted those values from the purchase price to determine the residual “bare land value” per acre. The bare land value was compared to past purchases and other available tracts to determine which purchases to make. So… we disaggregated into four pieces at most – timber value, reproduction value, OGM and bare land value. With the exception of the precalculated “reproduction table values”, the time value of money was not considered. Pretty simple. The objective was to manage the entire tract as timberland “forever”, not to sell off the various components. That methodology was pretty typical of the forest industry.

During the same time period (and earlier), land speculators frequently made money by the simplest form of disaggregation with only two buckets. They would buy a tract of timberland, sell the timber and then sell the bare land separately. Many speculators made a living doing this and some got very wealthy. The sum of the parts was worth more than the whole!

The REITs, TIMOs and their institutional investors have taken disaggregation to a whole new level. The objective is to lower the investment of the timberland purchase by quickly spinning off significant assets or components of the initial purchase. In addition to the components discussed above, the investment crowd values and disaggregates Higher and Better Use (HBU) lands, Recreation lands and Conservation Easements. In addition, future HBU lands are factored into the discounted cash flow analysis. The time value of money becomes an important part of the valuation relative to the early speculators that just bought, liquidated the timber and sold the land.

The impact of the disaggregation also has an impact of the final sale price of the investment. Conservation easements can significantly lower the final sale price. Conservation easements that prohibit development are, in a sense, the early sale of HBU land that just hasn’t got there yet. Conservation easements which dictate how the forest is to be managed in the future are much more problematic and should be expected to have a more significant negative impact on the valuation of the timberland when it is sold.

The next post will focus primarily on productivity and how that fits into today’s appraisal systems which use discounted cash flow techniques to determine the value of timberland. --Brian

4 comments:

  1. Very useful. Thanks Brian. I look forward to reading the series.

    ReplyDelete
  2. Look forward to the next post.

    -Novice

    ReplyDelete
  3. What a great series! Thanks for posting on this topic.

    ReplyDelete
  4. Great blog. I just found it. I would like to send you free copies of my magazine, I think you would enjoy it.

    WV guy here myself.

    Send me an email (publisher@landreport.com) with your mailing address and I will send you copies of our publication. Be sure to check out our website Brian, www.landreport.com

    I subscribed to your blog today.

    ReplyDelete