A BRIEF TIMO BACKGROUNDER

In discussions with newcomers considering investments in timberland or the publicly traded timber REITs, I frequently find that there is substantial misunderstandings about what a TIMO is and what the TIMO role is in the investment community. This backgrounder is intended to answer those questions. For a much deeper understanding of TIMOs, here is a link to an outstanding and in depth report prepared by Cliff Hickman with the U.S. Forest Service. It was prepared in early 2007 so some of the numbers are out of date but, other than that, it is the best researched report on TIMOs and REITs that I have seen.

What is a TIMO?

A Timberland Investment Management Organization. Note that the first word is timberland, not timber as it is so often written. There is a big difference. Timber refers to trees, timberland is land with trees on it! Many news articles in well-known financial news publications (WSJ, Barron's) have confused the two in recent years, which has led to significant confusion surrounding pricing and values of timberland. The second key point is that TIMOs do not own land; they buy land, manage it and sell it for their clients. They have teams experienced in both forest management and portfolio management. For this advice and service, they charge a fee.

Some history…

During the 1980’s, institutional investors began recognizing the value of adding timberland to their portfolios. By the early to mid 1990’s, there was a call by many analysts in the investment community for the pulp and paper companies to monetize their timberlands to reduce debt. More favorable federal income tax rates and accounting policies applied to the TIMO’s clients than the pulp and paper companies, which made the timberland more valuable for the former compared to the latter. Growth of the TIMOs was rapid as investors sought to acquire timberland and the pulp and paper companies sought to dispose of it. The companies that did not sell their land generally converted to the REIT form of corporate structure to provide higher after-tax returns for their shareholders.

Who are the TIMO’s clients?

They are large institutional investors with a focus on financial objectives, many of which are tax exempt. Specifically:

• Pension funds
• Public retirement systems (CalPERS, the California public employee retirement system, was one of the first and largest timberland investors). European pension funds invest in U.S. timberland also and U.S. funds own timberland in other countries.
• Corporate pension funds
• University endowments (Harvard and Yale were among the first institutional timberland investors)
• High net worth individuals and families
• Hedge funds
• Foundations

Note that the clients are all large investors.  The largest clients generally acquire land in separate accounts while some of the smaller clients participate in accounts with commingled funds. TIMOs are not structured to accommodate most individual investors (there are other good options for individuals though).

How do TIMOs differ from the so-called Timber REITs?

TREITs, or Timber Real Estate Investment Trusts, own the timberland, TIMOs do not. The publicly traded TREITs are Plum Creek (PCL), Potlatch (PCH), Rayonier (RYN) and soon to be Weyerhaeuser (WY). The tax structure for REITs allows the profits to be passed through to the shareholders avoiding the double taxation associated with the C corporations. That tax efficiency is why Weyerhaeuser is converting to a REIT.

How much timberland do the TIMOs manage?

The TIMOs manage approximately 25 million acres worth more than $30 billion. The three REITs (not counting Weyerhaeuser) own about 11 million acres worth about $15 billion. Including Weyerhaeuser, the REITs own about 17 million acres worth about $28 billion.

Who are some of the TIMOs?

Below is a list, in alphabetical order, of some of the largest TIMOs. All of them have web sites that you can google to get additional information about them.

• Conservation Forestry
• Forest Capital Partners
• Forest Investment Associates
• Forest Systems
• Global Forest Partners
• GMO Renewable Resources
• Hancock Timber Resources Group
• Lyme Timber Company
• Molpus Woodlands Group
• ORM/Pope Resources
• Resource Management Services
• RMK Timberland Group
• The Campbell Group
• The Forestland Group
• Timberland Investment Resources
• TimberVest
• Wagner Forest Management

Are there differences between TIMOs?

Yes. They have different investment philosophies that appeal to investors with differing objectives. For example, The Forestland Group invests primarily in natural forests, particularly hardwood. The Hancock Timber Resources Group puts an emphasis on forest technology to improve timber yields and financial returns. Some TIMOs focus on acquiring “conservation land” or land that can have “conservation easements” quickly sold and separated from the fee ownership. Some TIMOs have good information systems with strong financial controls and some do not. Some conduct field audits, some do not. Some have outstanding technical groups in-house, some contract it outside. Some manage the timberland themselves and some contract with consulting foresters. All of these issues should be weighed by investors and the right TIMO selected based on the objectives of the investor.

This post can be downloaded as a pdf here. Visit  the Timberland Strategies web site here. --Brian

Email: jbfiacco@gmail.com

The Trend in Timberland Prices

The current issue of Forest Landowners Magazine published an article that I wrote a few months ago that looks at the trend in timberland prices over the last decade. It examines the changes, data sources and some transactions during the first half of this year. It also tries to answer the following questions:

• What has caused timberland prices to stay up while timber prices and most investments have declined in value?
• What would cause prices to decline?
• So what does the future hold?

If you are interested in reading the article, here is a link to it on my web site. --Brian

The Future Forest Industry

I was recently asked to speak at the North Carolina Forestry Association’s annual meeting in Myrtle Beach. The topic was to be “THE FOREST INDUSTRY OF THE FUTURE, What will it look like?” Before agreeing to the talk, I had to think about it for a while. The quote “Its tough to make predictions, especially about the future.” Attributed to Yogi Berra (as most quotes are) hung in my mind for a few days. But I agreed to take a shot at it and gave the talk earlier this month. I thought I would share a few of the points with you.

First, there has to be a basis for the prediction. The basis that I chose was to look at the changes occurring in the forest industry and to look at what I thought the future economic environment might look like.

The Three Key Changes in Progress

• Changing Timberland Ownership

• Shift from forest industry to institutional and other owners
• Well under way and well documented

• Biomass for Energy

• Not a new thing but impact is changing
• Sourcing moving from residue to pulpwood
• Sheer magnitude is not well understood

• Global Industrial Revolution

The shift in timberland ownership is well documented so I didn’t spend any time on that whereas the magnitude of the biomass issue is not universally well understood and merited significant discussion. Slides focused on the biomass drivers, sources (Residues or pulpwood? Answer: pulpwood), nationwide energy sources and biomass utilization examples. There is also one slide on the cost of alternative transportation fuel costs (including cellulosic ethanol) relative to the cost of oil. It is a somewhat complex slide but the story it tells is that as oil goes up in price and as research brings costs of alternative fuels down, demand for biofuels grows in leaps. When I gave the talk less than two weeks ago, oil had settled into a trading range around $70. It is now approaching $80.

My view of the drivers behind the economic future looks like this:

• Social drive for renewable energy, energy self-sufficiency and climate change
• High energy costs- The key cost escalator
• High Inflation Rate (perhaps hyperinflation) Driven by:

• Very high government spending
• High oil prices

• Declining Dollar
• Global Industrial Revolution
• Commodity Shortages (natural resources)

There is a series of slides supporting my economic assumptions followed by a series painting my opinion of the future for sawmills, pulpmills, the wood supply chain and the future forest. A brief synopsis follows:

•Biomass/Power companies will be a key part of the industry.
•There will be more “in-woods” operations (chippers, biomass harvesting, biochar, and perhaps mobile methanol).
•A smaller pulp and paper industry will survive and exporting will play a larger role.
•Sawmills: Demographics still favor housing and lumber export market will become significant. Imports less competitive.
•Logging contractors will have a more stable operating environment. Annual production contracts.
•Stumpage market will be more competitive and more stable.
•Plantation establishment will consider energy market.
•Timberland ownership will be a good place to be!

If you would like to see all of the slides, you can go to www.timberlandstrategies.com and navigate to the “Articles” page. The presentation is in html format, which destroyed the “Build” on a key slide (oil prices). I will be adding that one slide as a Powerpoint presentation with the build to make it easier to understand. Run slideshow. Objective is to show how oil prices and cellulosic ethanol (and, by inference, other wood based transportation fuel) costs are converging. Comments, thoughts and differing views are welcome. --Brian

Valuing Timberland V – The Discount Rate

This is the fifth and final post of a series on timberland valuation. If you missed the first post, which included an Overview plus a discussion on Disaggregation, you can read “Valuing Timberland I” here. The second post focused primarily on productivity and how that fits into today’s appraisal systems which use discounted cash flow techniques to determine the value of timberland. You can read “Valuing Timberland II” here. The third post focused on estimates of timber volumes and values, how we get them, and how to forecast them for future year’s cash flows. Read “Valuing Timberland III” here. The subject of the last post, Valuing Timberland IV, was on the methodologies used in discounted cash flow analysis. Today I’ll focus on the discount rate to be used in the cash flow model.

The “discount rate” is essentially the same thing as the interest rate used in any financial calculation. We have to get the series of future cash flows “discounted” back to the present so we pick the appropriate interest rate to do that. As an example, say you wanted to buy a tract of land and your credit union would lend you the money for 6%. You know there is some risk associated with this so you assign another 2% for risk. You would use a discount rate of 8%. Sounds simple to me.

Let me start off by saying “I don’t know what discount rate to use”! This question is argued by investors, economists and corporate finance types. But understand this, selection of the discount rate is the most important decision made during the valuation process. Let me illustrate.

Many years ago (I was working as a Land Acquisition Forester at the time) I decided to reread Thoreau’s “Walden” which led me to “In the Maine Woods”, “A Week on the Concord and Merrimack Rivers” and “Cape Cod”. Considering my job, Thoreau really got my attention with the following words from “Cape Cod”.

“Between the Pond and East Harbor Village there was an interesting plantation of pitch-pines, twenty or thirty acres in extent, like those which we had already seen from the stage. One who lived near said that the land was purchased by two men for a shilling or twenty-five cents an acre. Some is not considered worth writing a deed for.”

Thoreau had traveled across the Cape in the 1850’s and I had noticed and made mental note of these same pitch pine plantations while visiting there. So what would a Land Acquisition Forester think… “Man, what a buy that would have been!”

What if an investor knew what the values on the Cape would be like in 2008? Would he have bought some of that timberland for $0.25 acre? Maybe, maybe not. Let’s consider the opportunity and create a simple analysis. Let’s say that the investor could foresee all that wonderful HBU land on the Cape and actually KNEW what 2009 land prices would be like. Keeping it simple (so we can isolate the impact of discount rate selection), assume he leased the land out “for taxes” so he had no cash flows (positive or negative) other than the purchase and sale of the land. The data below shows the value of a $0.25/acre investment compounded forward for 150 years.






So…, would the investor have bought the land (for his descendents!!). It very clearly depends on the discount rate that the investor used. I don’t think that there is an acre of scraggly pine plantation on the Cape that could be bought for $1,562/acre and I doubt that you could sell an acre for over $300 million per acre either – not even the Kennedy compound. The value determined clearly depends on the discount rate used. So what discount rate would you have used? Think about that seriously. If the rate is too high (nice to get but will you get it!) you may never have the opportunity to make an investment EXCEPT one that is very risky.

When I was in forestry school (back in the 60’s) we normally used 6% in our forest economics courses. When I was an MBA student (in the late 70’s), we used the company’s marginal cost of capital with an appropriate adjustment for risk. Early in the timberland shift to TIMOs, it was pretty freely discussed that TIMOs were using real rates in the 6% to 8% which was based on the “risk free” rate of return (10 year T-bills at 4%) plus risk adjustment. At the same time, integrated forest products companies with large timberland acreages were using investment hurdle rates significantly above the average or even marginal cost of capital for the firm (a mistake – it should have been based on the marginal cost of capital and risk associated with purchasing and owning more timberland not riskier investments!). The result of this is that high-risk capital investments were subsidized by low-risk timberland ownership. As a general rule, discount rates used by the C corporations were much higher than that used by the TIMOs (rates in the range of 12% - 15% or more). Remember the decision you reached above with the Thoreau example. The C corporations also had to include taxes in the cash flow analyses (reducing cash flow and, subsequently, value) whereas most of the TIMO clients were pension funds and tax exempt. Between the tax payments and high discount rates used by the corporations, it is pretty clear why the TIMOs valued timberland higher than the forest industry.

Note two things from the above discussion. The “appraised value” of a particular tract of timberland, based on comparable sales, was the same for the TIMO buyer and the forest industry seller yet the real valuation for the buyer and seller were very different. As I pointed out in an earlier post; timberland valuation and fair market value are two different things!! The second point: the difference in discount rates used, combined with tax policy, has dramatically changed the face of timberland ownership and forestry practice in this country.

How do inflation and taxes affect the selection of the discount rate? We discussed that somewhat in the post on cash flows. Here are a couple of quotes, also from the Forest Landowners Guide to the Federal Income Tax, Ag. Handbook No. 718.

“it is imperative that the discount (interest) rate used for the analysis include a similar expectation factor for inflation. In summary, both elements of the analysis—cash flow and discount rate—must be kept in comparable terms (with or without inflation and before or after-tax) for reliable results.”

“Forestry investments are very sensitive to the discount rate used because of the long time period between planting and harvest. For after-tax analyses, the correct discount rate is the after-tax rate based on your alternative rate of return. If the next best alternative is a tax-free investment, such as a municipal bond, then the interest rate is used without adjustment, as shown in Table 2-3 for the 10-percent discount rate. If your next best alternative is an investment, such as a corporate bond, that yields 10 percent annually with taxes subtracted before compounding, the correct discount rate is 7.2 percent, after-tax [10 percent x (1 - 0.28 assumed tax rate)]. Alternatively, if the next best alternative is an investment such as an individual retirement account (IRA), certain saving bonds, or an alternative timber investment, where taxes are deferred until the end of the period rather than being subtracted before compounding, then the correct discount rate depends on the length of the investment period and when the costs are incurred and revenues received. Assuming an initial investment, 10 percent interest, and a 28-percent tax subtracted at the end of 34 years, the appropriate discount rate would be 8.94 percent.

Now, if you feel that you still need more info on how to select the right discount rate for a timberland purchase, let me give you a couple more references.

• “Timberland Investments” by Christian Zinkhan, et. al.
• “Discount Rates and Timberland Investments” by Brooks C Mendell in the Timberland Report published by James W. Sewall Company

Finally, it may be worthwhile to speculate a little bit (actually that is what the selection of the discount rate is). Timberland investors have watched as discount rates rose early in this decade followed by decreasing discount rates which resulted in a steady increase in timberland transaction prices (and corresponding values from comparable sale based appraisals). Some TIMOs have left the market so they clearly believe discount rates got too low and pushed prices too high (potential returns too low). Other TIMOs have tried to sell large blocks but pulled them off the market. Perhaps they think discount rates are too high but prices are too low to justify selling?? Or maybe there is less money chasing timberland. This concludes the Timberland Valuation series.

Oh, I almost forgot. Nobody is going to tell you what discount rate to use. That's your call. Comments welcome. --Brian

Valuing Timberland II

This is the second post on timberland valuation. If you missed the first post, which included an Overview plus a discussion on Disaggregation, you can read “Valuing Timberland I” here. Today’s 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.

Productivity is key to determining the value of timberland. Some of the productivity is inherent to the land itself and some is a function of the intensity and effectiveness of the silviculture practiced on the tract.

First, let’s look at the inherent productivity of the land. Foresters measure that with a metric referred to as Site Index. Site Index (SI) refers to how tall a given species of tree can grow on that particular site in a specific number of years. Examples might be Loblolly Pine, base age 25 years, SI 60. Or Red Oak, base age 50, SI 60. Or Cottonwood, base age 10, SI 60. All of these are realistic examples and I have worked in stands with these exact site indices. The sites are not similar though. Note that all of the examples are “Site 60” land meaning all of those species will grow to sixty feet in height but it takes the cottonwood only 10 years, the loblolly pine takes 25 years and the oak takes 50. The land supporting these three site indices would also look very different. So SI defines the productivity for a particular species on that site. As a matter of interest, the SI 60 examples given for Loblolly (25 years) and Red Oak (50 years) are reasonable and quite common. The SI 60 (10 years) for cottonwood is actually a very poor site. Cottonwood on a good site can attain 100 or more feet in 10 years! Neither loblolly pine nor red oak could even survive on these sites due to the prolonged flooding during the growing season. The site determines the best species to plant or to favor with natural regeneration.

Let’s look at site productivity in more detail. In the late 60’s and early 70’s I was buying timberland in North Mississippi and West Tennessee. My counterparts (in other regions) and I were tasked with developing a new appraisal system based upon minimizing the cost to the pulp mill rather than the minimizing the bare land value. A key component to valuation is the objective of the owner and I was working for a pulp and paper company that owned land for the purpose of supplying its mills. And remember this, timberland valuation and fair market value are two different things!! That’s why there is always a high bidder! Under this type of a valuation model (delivered cost), it should be very clear that the more productive the land (i.e. the higher the SI), the more wood that would be grown and the lower the delivered cost per ton would be. In addition, there was already a significant acreage of 10 to 15 year old established loblolly pine plantations on private land in the area that had been established by the U.S. Forest Service Yazoo – Little Tallahatchie flood prevention project. Cattle prices were high and the plantations were being cut, cleared and put into pasture. In general, fair market value for timberland in the area was essentially the pulpwood value of these plantations (very low because of their age) plus bare land value.

Our appraisal system team created the details for a model which estimated a future cost per ton delivered to the mill. Obviously, the tracts with the lowest cost per ton were the tracts most desirable to the company. Bare land value was still there and served as a checkpoint against “fair market value” (FMV). The new method was very different from the old in that it represented the beginnings of a cash flow model and timberland productivity became a very important driver. The “Growing Cost” of the model was actually a future value of the cash flows and was very dependent on the productivity of the tract. The impact of the increase in growth alone between SI 60 and SI 70 for loblolly pine is about 30%. Jack it up to SI 80 and the gain is almost 60%! It’s pretty easy to see the significance of productivity gains on valuations dependent on the amount of timber that will be grown in any given amount of time. The “take home” point of the last couple of paragraphs is that the greater the inherent productivity of the land, the more positive the impact will be on an appraisal system employing a discounted cash flow model. And the greater the price that informed buyers will pay for it. We’ll discuss more about the pine plantations mentioned above a bit later. But first we must talk a little more about productivity that we can impact and something called yield tables.

The second factor addressing forest productivity is silviculture. Silviculture can be briefly defined as - the art, science, and practice of controlling the establishment, composition, growth, and quality of forest stands. Silviculture is to the forester what agriculture is to the farmer. It is a broad term encompassing preparation of the site, selection of the species to be planted, selecting the seed with the best genetic capabilities, fertilization, planting, density control, weed control and harvesting. Silvicultural systems employing artificial regeneration, planting or direct seeding, are more in line with agriculture but natural stands employ similar practices to obtain the desired species composition and density control too. The decision to employ a silvicultural system with a focus on natural regeneration versus plantation management has a huge impact on cash flow and profitability (and therefore valuation). Natural forest management regimes have less cash out and less cash in. Which system, natural or plantation, is best depends on the objectives and circumstances of the owner. So…, site quality refers to the natural productivity of the site whereas silvicultural activities are things that we can do to increase the productivity of the forest. At a cost.

To a degree, the current productivity may be what nature provided us (really it is more what past “managers” left us with rather than what nature provided us with). The existing forest type (a classification of forestland based on the species forming a plurality of live tree stocking) may be a 20 year old oak-pine stand or a 10 year-old loblolly pine plantation. The two have very different productivity potentials going forward. There could easily be a five-fold increase in productivity between the two forest types on similar sites. In some cases, the forest manager has the option of changing forest types through the process of harvesting, site preparation and planting. Greater productivity, greater cost.

Inherent in the example above is greater control of stand density or stocking through planting. Control of stand density is critical to maximizing productivity. So what is stand density? I don’t want to get into a forest mensuration short course here so just think of stocking as the combination of the number and size of trees that will provide optimum growth for a particular site. Stocking charts frequently classify stands as “understocked”, “well stocked” or “overstocked”. A “yield table”, mentioned earlier, combines the stocking level with Site Index to forecast what the yield of forest products will be at some future point. This tool is critical to determining the future productivity of the forest and to the timing necessary for the discounted cash flow analysis. For the purpose of explanation and understanding, I have created the super simple yield table below.



A “real” yield table can go on for pages with many different site indices, ages, stocking levels and products but this one will illustrate the points that I am trying to make. Note how the yield (in this case cords/acre at age 25 but could be MBF at age 20) changes with both stocking (trees/acre at Age 1) and site index. Using these variables we can forecast both volumes and cash flow at the time of harvest. And what if we plant genetically improved stock that increases growth that is the equivalent of a 10 point jump in SI? Or phosphorous fertilization on a P deficient soil? Silvicultural activities have a major impact on the yield but “in the old days” we were pretty well restricted to the yield tables and they served us quite well. Today, however, they have generally been replaced with much more sophisticated growth models which are not only capable of predicting growth based on stocking and SI, but on all of the silvicultural practices that impact those metrics.

I feel that I have rambled a little too much in some places and not been clear enough in others so let me summarize the key points.

Forest productivity, both inherent (SI) and developed (silvicultural activities) is probably the most important driver in the cash flow analysis of timberland. Tools are available to measure and project the volumes into the future. Yield tables for volume projection have been replaced by growth models. You can download and learn to use a loblolly growth and yield model from Mississippi State here (CUTOVER LOBLOLLY GYM). It allows you to manipulate the SI and stand density and to see the future output. It also allows you to assign values by product which we will discuss next time.

Timberland valuation and fair market value are two different things! Remember above when I talked about buying 10 to 15 year old established pine plantations? The FMV (based on comparable sales) was about $125/acre in 1970. We began paying $150 - $175/ acre and easily acquired a significant acreage of these plantations. The value that we were assigning was the future value discounted back to the current age as opposed to FMV. Ten years later we were harvesting $1000/acre worth of chip-n-saw from these sites. We recognized that the FMV was well under the actual value of the plantations and were able to capitalize on that. Some of the early TIMOs were able to do the exact same thing with pre-merchantable plantations on a much larger scale. Some of the early TIMOs saw the value in HBU lands and disaggregation and recognized that the sum of the parts was worth more than the whole. These values are now well recognized in a competitive market and the returns, as expected, are dropping. The lesson is that there is a good return to be had if you can recognize a difference between the real value and the FMV.

Location can be very important or fairly minor. In the case of a forest products company valuing timberland, distance to the mill can be critical (as is the case with an institutional investor committed to a fiber supply agreement requiring delivery!). Some states have real estate tax structures which have a significant impact on cash flow evaluations. But frequently, location has minimum bearing on valuations for an investor.

So much for the value of productivity. The next valuation post will focus on estimates of timber volumes and values, how we get them, and how we forecast them for future year’s cash flows. We will also take a quick look at the confidence you should place in them. --Brian

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

The Vertically Integrated TIMO?

One of my readers pointed out an interesting development to me recently. As has become so obvious, the vertically integrated forest product companies (VIFPC) are almost a thing of the past due to the elimination of favorable capital gains tax rates and the high tax rates on C corporations. The pass-through tax structure for TIMOs (pension funds) and REITs has pretty well destroyed the VIFPC as a viable tax structure. So the new landowners and managers become true timberland companies unburdened by the tax structure brought by those pesky mills.

The interesting observation is that The Forestland Group has recently completed the first part of the purchase of Roy O Martin's LeMoyen, Louisiana, hardwood sawmill, 10,000 acres of hardwood timberland, and 20-year harvesting rights on an additional 138,000 acres of hardwood timberland in south Louisiana. Read more.

Now back up about two years to when Anderson-Tully "merged" with one of The Forestland Group's funds. ATCO had a huge hardwood sawmill in Vicksburg billed as the largest hardwood sawmill in North America. You can read about that transaction here.

So now we have a new acronym (we need a new acronym), the VITIMO! It will be interesting to watch this trend develop, if it is a trend. When The Forestland Group buys its first pulp mill, I'll know its for real! --Brian

More on the Economics of Longleaf Pine

What follows is an invited Blog on the economics of longleaf from a commercial perspective. It was written by the folks at FORSight Resources. I think one of the key components of the comparative economic analysis that still needs to be addressed is the difference in stumpage value at harvest between loblolly and longleaf when poles are factored in. Perhaps some readers have a few comments that will address the subject. Thanks to Bruce and his crew at FORSight for taking the time to provide additional insight into the economics of longleaf. --Brian
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The past decade has seen significant shifts in timberland ownership, particularly in the southern U.S. Integrated forest product companies have sold many of their land assets, which have subsequently been acquired by institutional investors. Timberland investments are often made by Timberland Investment Management Organizations (TIMOs), who both acquire and manage property on the behalf of institutional investors. Many TIMOs function as closed-end funds, meaning a key aspect of TIMO management is a short time horizon relative to integrated forest products companies. While forest product companies have traditionally held land ‘forever’, these closed-end funded TIMOs often plan to hold land for no more than 10-15 years.

Along with shifts in forest ownership, the past decade has also seen increased interest in longleaf pine management. In recent years, various organizations have begun encouraging longleaf plantation establishment with much of their effort directed at private landowners whose objectives include factors such as wildlife habitat and aesthetics in addition to economics. Little work has been done examining the economic viability of longleaf pine management on investment properties. This can be attributed to the commonly-held belief that returns from longleaf management cannot compare to those from loblolly pine plantations. TIMOs may be able to justify investments in longleaf pine plantations if they can show returns comparable to those from intensive loblolly pine management. This is particularly true given the higher amenity values attributed to longleaf pine.

To address this issue, the financial performance of loblolly and longleaf pine plantations were compared for four cases, each with low and high site productivity levels and each evaluated using 5% and 7% real discount rates (Table 1). Management regimes were selected for comparison from a reduced set of acceptable alternatives, which were constrained by management intensity and treatment timing. The regimes that maximized Land Expectation Value (LEV) for each site/discount rate combination were chosen for analysis. LEV is the present value per acre of the projected costs and revenues from an infinite series of identical rotations starting from bare ground.

Longleaf pine stands were simulated using FORSim Longleaf Pine Growth Simulator (www.FORSightResources.com) and loblolly stands were simulated using LobDSS (www.forestnutrition.org) which uses the FASTLOB2 whole stand growth and yield model (www.fw.vt.edu/g&y_coop/). Product prices and management costs and application rates were typical of the Southern US. Land expectation value (LEV) and present net worth (PNW) for the first rotation were calculated for each selected regime using both 5% and 7% real discount rates. Because loblolly and longleaf rotation lengths differ, LEV provides the only means for directly comparing results. Present net worth provides a means for analyzing cash flows over the short term.

Financial analysis results are shown in the last two columns of Table 1. The addition of pine-straw raking to longleaf pine management regimes resulted in greatly improved financial results (13-70% higher) that compared favorably with the loblolly pine management regimes. The loblolly regimes produced LEV values 3-16% higher than longleaf with pine straw raking in all cases except case 4, which exceeded the corresponding loblolly LEV by 2.6%. An examination of the cash flows reveals that the cumulative PNW ($/acre) from loblolly pine plantations remained negative until the final harvest in all cases. Interestingly, the economic rotation for longleaf without straw raking in case 1 (lower site, 5% rate) was shorter (32) than loblolly (35); in all other cases, loblolly economic rotations were shorter than longleaf, regardless of pine straw. Pine straw raking resulted in economic rotations for longleaf that were more than 10 years longer in all cases except case 4 (higher site, 7% rate) where the economic rotations for longleaf were the same (27). Pine straw harvests yield positive cash flows earlier in the rotation, especially for longleaf pine plantations on lower sites and evaluated using lower discount rates.

Table 1. Cases examined and financial results of each. Highest financial results in boldface.




Results indicate that longleaf pine regimes that do not incorporate pine straw raking yield financial results that are inferior to those from intensive loblolly management. However, with the addition of pine straw revenues, longleaf management can yield returns that are comparable to typical loblolly regimes. Longleaf pine plantations with pine straw harvests produced greater LEV than loblolly plantations on lands with higher site index (80 and 110 feet for loblolly pine and longleaf pine, respectively) when using the higher discount rate (7%). Other longleaf pine management regimes produced lower but comparable financial performance.

At lower discount rates longleaf pine regimes with pine straw raking provided positive cash flows sooner than loblolly pine. In all cases, however, positive cash flows were not achieved with any regime until after age 23. This result is noteworthy because this is longer than the expected land tenure of many closed-end funded TIMOs. Because there is likely to be little to no direct return on reforestation investments under such short land tenures, a logical consequence may be the minimization of reforestation expenses. Thus, longleaf pine may be a more attractive alternative, given a 25% lower initial silvicultural investment and the favorable LEV comparison. This analysis suggests that timberland owners managing strictly from the economic perspective should re-evaluate longleaf pine as a viable alternative to loblolly plantations. The tradeoffs for managing a species often considered to have higher amenity values than loblolly pine is not nearly as substantial as often believed.

This posting is a summary of a detailed paper prepared by the staff of FORSight Resources. Please visit FORSight Resources to download a copy of the complete white paper.

FORSight Resources is a leading provider of decision support services for natural resource management. The company’s main business lines are forest planning and harvest scheduling, timberland acquisition due diligence, forest inventory and biometrics and forestry GIS. For more information on FORSight Resources, LLC contact Bruce Carroll at 843.552.0717 or Karl Walters at 360.882.9030 or email: info@forsightresources.com.

On the Marginal Return from Timberland Investments

I own stock, I own timberland. Each provides an economic return that is somewhat comparable to the other. Sophisticated analysts compare the two asset classes to determine which is actually best. In the end, I think timberland usually wins the contest by a small amount.

When I get up in the morning, I have my coffee and then head out the door with Sophie. About four steps from the door I am walking in the woods and enjoying the marginal return that comes from a direct investment in timberland. Sophie has me by the cuff dragging me down the slope to see if we will see ducks, geese, a Great Blue Heron or maybe even an otter if we're lucky.
She runs as fast as she can go, stops abruptly, and then freezes into that handsome pose of a pointer.

The individual investor is sometimes at a disadvantage to the institutional investor when it comes to buying and owning timberland. Economies of scale make it more economical to both purchase and manage large tracts. Yet when the pension fund manager is working diligently balancing the portfolio for the funds clients, the owners of the Family Forest can be balancing on a log crossing the creek.

Sophie breaks her point, flushes three wild turkeys, my heart races and the marginal return jumps a point! It all evens out. --Brian

Changes in Timberland Investments in the South

There is an outstanding paper by Tom Harris, Jacek Siry and Sara Baldwin (the TimberMart-South crew) that can be downloaded at no charge from Forestweb's site. The paper looks at the major changes and trends impacting forestry investments in the U. S. South. An outline of what is covered follows:

• "Major Changes in the U. S. South: New items worthy of note
  »» A decade of timber price declines
  »» Retirement of the vertically integrated model for forest products
  »» Improved competitive position
  »» Maturing forestry investment industry
  Southern Timber Trends: Key, Overarching Issues
  »» Globalization
  • Increased Global Trade in Forest Products
  • Shift in Manufacturing
  • Role of Paper in Communications
  • Energy and Bioenergy
  »» Abundant Timber Supplies
  • Planting Rates down
  • New emphasis on thinnings
  »» Consolidation and Dis-integration
  • More concentrated products markets.
  • Dis-integration essentially complete
  »» Forestland Ownership Shifts
  • New owner objectives and investment horizons unclear.
  • HBU based values assuming new importance.
  A long-term history shows nominal increases in stumpage prices"

The paper is well illustrated with charts and graphs illustrating the authors' observations. It covers "all the usual suspects" (price trends, ownership changes, transactions, etc.) but I think the most interesting observation is the impact of the declining U. S. dollar. The charts compare delivered prices of conifer pulpwood in the major wood producing regions as well as a more detailed comparison (see graph) between the U. S. South and Brazil. Guess what? The South is now very competitive!! So while we hear all of the wailing and gnashing of teeth due to the falling dollar on the nightly business shows, there is a very positive impact in our manufacturing sector (more jobs, higher wages, higher stumpage prices from increased demand? etc.).

I would recommend reading FORESTRY INVESTMENTS: Major Changes in the U.S. South made available from Forestweb. Harris and bunch did a good job. --Brian

Strategic Factors Driving Timberland Ownership Changes

This post references another paper examining the changes resulting from the shift in timberland ownership from vertically integrated industrial companies to TIMOs and TREITs. The paper was written by Mike Clutter (University of Georgia) and Brooks Mendell, David Newman, David Wear and John Greits (all with the USFS). The study was funded by the Forest Service. Following are a few extracts, kind of at random, that I found important or just interesting:

• "more efficient tax structures for owning timberland have evolved - such as single-taxed real estate investment trusts (REITs) and S-corporations - replacing the traditional double-taxed C-corporations..."
• "Client preferences and investment horizons impact the choice of silviculture treatments, leading TIMOs to tend to invest in silviculture early in the life of the investment funds, but not later."
• On TIMOs: "We make money on growth."
• On TIMOs: "Appraisals drive our business." Note that this comment and the one before it both get to the difference in accounting (GAPP) that allows such things as timber growth and appreciation in land prices to be treated as an annual return for the TIMOs but not for the C-corporations. Note too, that if a silvicultural activity, like mid-rotation release, doesn't increase the appraisal at least as much as it cost, it won't be done. Question - how good are the appraisers? Do appraisals reflect what is not seen?
• "TIMOs, without exception, focused on the financial metrics of concern to their clients. ...this measure was some variation of cash return plus asset appreciation, as established through appraisals."
• "These metrics reflected a general attitude toward silviculture treatments. ..., it’s ‘what will the market pay for this treatment if applied?’"
• "TIMOs view silviculture information as a "commodity" and, in general, appear reluctant to invest in long-term research or forestry coops. ..." In other words, if the impact does not show up in the growth and yield models or appraisals, it does not pay to make the investment."
• On community presence or public affairs: "TIMOs ... relied on their forestry contractors to establish and maintain sufficient working relationships within the communities." Some exceptions to this.
• "...fragmentation was not viewed as a major concern or priority by any interviewee."
• On fire control: "TIMOs and forestry consultants rely almost entirely on state resources. ...To assess the southern States fire suppression assets available for use we talked with all of the Fire Fighting Coordinators for each state... As expected, ... Most southern states have experienced significant reductions in private fire suppression capability during the past 15 years, the time frame during which industry ownership has been declining.
• "The thirteen responding states report reductions in the availability of 700 private cooperator-owned and available tractor/plow units. Of the thirteen states, only Kentucky has not reported a reduction; others ranged from 12 to 142 (Georgia). Notably, Kentucky has the smallest share of forest industry ownership in the South. Limited reductions in air tanker availability (4), 20 person hand crews (1), and helicopters (1) were also reported."
• "shareholders, analysts, and executives of the traditional vertically integrated forest products firms believe that returns on industry-owned timberlands lagged alternative investments, a fact complicated by the lack of recognition of asset appreciation and growth on forest products firms’ income statement."
• "In the preponderance of transactions ownership changes did not lead to substantial land use changes."
• "we expect these timberland ownership trends to continue. Within the next three years we expect that there will exist only one traditional forest products company that owns more than a million acres in the southern United States."
• "The other trend that will continue to impact timberland ownership is the continued growth of rural real estate markets at the urban / rural fringe. Continued emphasis will be placed on identifying those acres and monetizing the assets as they become more valuable for other uses."

Read the entire report: Strategic Factors Driving Timberland Ownership Changes in the U.S. South. See the quick version in The PowerPoint Presentation

There are no surprises in this research but it has helped to document those things that we have seen. --Brian

TimberVest and GMO TIMOs Share $60 million

The San Bernardino County Employees Retirement Association is recognising Timberland as an asset class separate from Real Estate and, with that recognition, is doubling the amount of money to be invested in timberland to 4% of its portfolio.

According to IPE Real Estate:
"The outcome of a recent fund board meeting was that the pension fund made two commitments to two timber commingled funds. One was a $30m ($22m euros) to the Timber Vest Partners II fund, which will be a commingled fund with a total equity raise of $600m. The investment strategy is to invest in timber in the US."

"San Bernardino County also allocated $30m to invest in GMO Long Horizons Forestry Fund. This commingled fund will have a total equity raise in the neighborhood of $300m to $350m. This investment fund will be looking for assets in the US and internationally. "

The pension fund is expecting a real rate of return of 6% over the next 10 to 20 years. Reportedly, the fund will be ready to invest another $40 to $60 million in Q1 and Q2 of next year. Read the entire article here. --Brian

Temple-Inland's Timberland for Sale

Temple-Inland has announced that it is splitting the company into three pieces and selling its "1.8 million acres of timberland in Texas, Louisiana, Alabama and Georgia." This should cause a little excitement among the TIMOs along with some late night and weekend work for a few folks!

Icahn's comments: "Temple-Inland's management and board of directors should be commended for listening to the concerns that we and other shareholders have expressed and for announcing plans to take the actions we suggested" Looks like he made his money without a takeover. The stock was up 13% on yesterdays news. Click here for a little more detail.

Increasing Investor Interest in Timberland

If you have been watching the stock price of the timber REITs for the past few months, you should have noticed some pretty dramatic gains (way above all market indices!). Plum Creek went from about $34 into the low $40's. When they announced lower earnings and a less than optimistic outlook, the stock price barely hiccuped. Potlatch is up. Rayonier jumped. In fact, during the last 30 days when the S&P jumped about 1.5%, PCL, PCH, RYN, TIN, WY, & JOE are all up from 6% to 12%! What's happening?

Private investors are looking for the pure timberland play but it's hard to buy a tract of timberland (at least in a knowledgeable manner). And that timberland is not too liquid either but a share of one of the above companies is. And private investors with the big bucks have the same thing in mind. Example: Carl Icahn moving heavily into Temple-Inland.

On the institutional investor side, the demand for timberland just keeps building and getting more competitive as more institutional investors recognise timberland as an asset class in itself. What started with institutional investors here in the U.S. is now spreading world-wide at a pretty fast pace. Here is an interesting article that illustrates the increased interest by investors in Europe. All told, there is a lot of money chasing timberland with no outlook on the horizon suggesting that the demand will decline anytime soon.

The Most Important Change...

in timberland today is clearly the shift in ownership from forest industry to TIMO's, government and NGOs. I have heard many comments suggesting that the shift to TIMOs is a bad thing but, if we believe in capitalism and free markets, then we have to think otherwise. Good or bad, though, is like beauty - its in the eye of the beholder. One person would think that all of the IP lands that went to the Nature Conservancy was a great change. A mill owner needing hardwood sawlogs might not think it was so good!

But one thing is for sure, things will be different and that is not just in the eye of the beholder. Let's throw out for thought what some of those changes might be. First, what about productivity of the land from the perspective of forest products. There is a lot that goes into this ranging from silvicultural investments to the length of ownership. The forest industry's ownership horizon used to be to own timberland "forever". Not so for TIMOs which normally have a relatively short time horizon and factor in the value of "flipping" HBU (Higher and Better Use) lands at the time of acqusition. I once bought a tract of land in Mississippi at a very favorable price because the owner felt that if he sold to a paper company he would never have to worry about having neighbors close by because the land was sold for building lots. Those days are gone. TIMOs are clearly more likely to capitalize on the HBU lands than industry did historically. This pulls forest land out of productivity (not a bad thing, just a fact).

Recently while attending a Tree Farm meeting I was listening to comments about how the TIMO sales of HBU lands to homeowners and hunters was creating a serious forest fragmentation issue which I suppose is somewhat true. What wasn't said is that these sales are also creating a wonderful opportunity to bring many more people into the Tree Farm System and to add to the political strength of those owning Family Forests. So there are pros and cons surrounding fragmentation.

Productivity is greatly impacted by silvicultural investments, particularly in young stands. I'm not sure how TIMOs compare to forest industry on that issue. I know some TIMOs that practise very intensive forestry and some that do minimal work and just hope the value increases. There is a big difference between TIMOs. But guess what - there was/is a big difference between companies in the way industrial land was/is managed. I'm not sure what or if there is a net difference.

In the area of basic research and developing and implementing technology, the TIMOs clearly fall down. The historically long term view of industrial firms is absent with the shorter time horizons of TIMOs and basic research is gone. TIMOs seem to be very good at implementing proven technology if, and only if, the gain will show up in the next annual appraisal. Forest research must come from academia and government in the future, right? Maybe not. Capital markets will come to the rescue and provide the technology needed (you do have faith in capitalism!). As industry disposes of its nurseries and research wings, a new industry will emerge to provide those products and services (we are already seeing it develop) and my guess is that the new industry will deploy its capital more efficiently that has been done in the past.

Now let's think about fire control. As industry has sold land it has also disposed of, or significantly scaled back on the fire fighting assistance that it has provided to state fire control organizations. When the largest timberland owner in the U.S. sold its lands to TIMOs and NGOs, the seller no longer needed fire control equipment and its pretty safe to say that the new owners had little interest in maintaining fire control personnel or equipment (somebody tell me if I'm wrong!). Now, what about our faith in capitalism and the thought that capital will flow to meet this need. Perhaps the faith is misplaced here and these new buyers (TIMOs, NGOs, Tree Farmers, homeowners, hunters. etc) need to step up to the plate and provide very strong support for funding of state forest fire control organizations. That means through both lobbying and increased taxes on forestland focused 100% on improved fire control. This will not happen until after a major calamity. In the meantime, state fire control budgets will shrink (in real dollars) as government finds "better" places to allocate its expenditures.

So..., what's the net change in productivity as a result of all these changes? My guess, and that is all that it is, is that productivity goes down mainly as the result of a decline in productive acreage. That's bad. Or is it. Pulpwood demand has dropped significantly in the U.S. so maybe the productivity decline will be a good thing. Or maybe we will come to understand that people would rather eat than have gasoline made from corn ethanol. Or see timberland and wildlife habitat cleared for corn fields. Perhaps soon a President will wake up to the fact that he/she has a nation with forests capable of providing ethanol (and other forms of fuel) and a very capable research team already in place that is capable of making it happen. Then forest productivity will once again be a major issue and timberland investors will be smiling. And capital will flow to forest research! and to silvicultural expenditures! and to fire control! But that's a thought for another day. --Brian