Investors have traditionally concentrated on classic asset classes like stocks and bonds to build their portfolios. Further diversification is usually achieved by buying properties or commodities. Relatively few investors venture into timber investments. That’s because timber has been considered to be a niche investment that is reserved for the ultra rich or for institutional investors. To some extent, this understanding about timber investments is correct. If you want to make a sizeable timberland investment, your outlay could run into millions of dollars.
In fact, investors like the $27.2 billion Yale Endowment Fund and the $37.1 billion Harvard endowment reportedly have large investments in forest land. But individual investors with lower investable amounts can also benefit from timber investments. It’s a mistake to think that this asset class is restricted only to high net worth individuals. Small investors can buy stocks in timber companies or timber Real Estate Investment Trusts (REITs).
- Benefits of investing in timber
- Timber Investment Management Organization
- How to invest in timber
- Timber investments are not without their share of risks
- Diversify your portfolio with timber investments
Benefits of investing in timber
Timber investments can be extremely profitable. According to a recent report in the New York Times, the National Council of Real Estate Investment Fiduciaries Timberland Index has returned an annualized average of about 12% since 1986. While that’s an enviable rate of return, it is available only to large investors. The NCREIF Timberland Index tracks the investment performance of a large pool of individual timber properties acquired in the private market for investment purposes. The total value of properties that the index tracks exceed $25 billion.
Timber investments are attractive for several reasons. The land on which the trees stand is in limited supply. Consequently, timber output is limited. Additionally, timber production cannot be ramped up in a hurry. Trees take years to grow and increased demand for lumber usually results in an increase in timber prices.
Increased demand results in higher timber prices
In recent months, demand from the housing market, which accounts for a large portion of the requirement for timber, has been rising. According to data issued by the U.S. Census Bureau and the U.S. Department of Housing and Urban Development, privately-owned housing units authorized by building permits in March 2018, stood at a seasonally adjusted annual rate of 1,354,000, which is a 2.5% increase over the previous month. Compared to March 2017, it is an increase of 7.5%.
What effect has this had on timber prices? Not surprisingly, they have shot up. A report in the Wall Street Journal points out that timber for a typical home now costs $8,500 more than it did a year ago. The rise in timber prices is not because of increased demand alone. Fires have destroyed prime forests and a trade dispute between the U.S. and Canada has reduced supplies to American builders. What if the demand from the home building sector falls or if an excess of timber floods the market? Will a glut of timber, lead to a fall in timber prices?
Timber Investment Management Organization – TIMO
There is a limited possibility of that happening as large areas of forest land are now managed by Timber Investment Management Organizations. A TIMO acts on behalf of institutional clients. Its responsibilities include:
- Identifying suitable timber investments.
- Analyzing the investment returns that these can provide.
- Acting as investment managers for investors. The TIMO will work towards enhancing profits and ensuring that investors receive a regular cash flow.
How does a TIMO make sure that investing in timber is profitable for its clients? It’s important to remember that timber investments are long-term in nature. The maturity period for pine, cherry oak, or maple could range from 15 to 30 years. The Timber Investment Management Organization tracks the timber market carefully.
If it is economically viable, it waits for the trees to mature before harvesting them. But trees can yield revenues and profits even before they are mature. They can be harvested for making pulpwood if the price of this raw material for the paper industry is remunerative. Wood has a number of different uses and TIMOs use their expertise to maximize returns for their investors.
Note – Plum Tree, which was the second-largest timberland company has merged into Weyerhaeuser. The combined entity, which retains the name Weyerhaeuser and is structured as a REIT, is the largest timberland company. The combined firm owns about 13 million acres of timberland.
How to invest in timber
Buy a woodlot
The traditional method to make a timber investment is to buy a woodlot. An individual investor can purchase approximately 50 to 200 acres, or a little more, of forested land. If the buyer does not have the expertise to manage the land, it is possible to engage a forester to carry out this task. The forester’s skills and experience help the investor to decide on how to maximize the returns from the woodlot. However, this usually does not yield a significant level of return as the size of the operation is too small to produce substantial revenues or profits.
But you would probably not lose money either. It’s just that large returns accrue to bigger parcels of timberland. Investors in woodlots that are about 50 to 200 acres in size are usually nature lovers and their prime motivation for the purchase is not commercial.
If you wanted to make a timber investment for the returns that it can provide, you would probably have to invest a larger amount. Jim W. Hourdequin, managing director of Lyme Timber, in Hanover, New Hampshire, explains, “I’d say it’s not until you get into a $1 million-plus range that you’d start getting into properties that are mostly driven by investment return”.
However, this may not be an option for every investor. Firstly, it involves a large cash outlay. If you were looking for diversification, a timber investment should normally form a small part of your portfolio. If you have to invest a million dollars for buying timberland, your total portfolio could become dependent on a single asset class. Making such a large timber investment carries other risks as well. Your trees could be destroyed by a fire or by insect infestation. For most investors, buying timberland in this direct manner is not the best approach to follow.
Exchange-traded funds (ETFs)
There are a number of exchange-traded funds (ETFs) that allow you to gain an exposure to timber investments. The great advantage of taking this route is that you have to put up a relatively small amount, usually as little as a few thousand dollars. An ETF is similar to a mutual fund, but there are some basic differences.
As its name implies, an exchange-traded fund can be bought and sold on the exchange. But a mutual fund can only be purchased from the investment fund company. Similarly, when you want to liquidate your investment in a mutual fund, you have to approach the mutual fund issuer.
The iShares Global Timber & Forestry ETF is a good timber investment fund option. It has a fairly low expense ratio of 0.51% and has returned 13.95% in the period from January 1, 2018, to April 27, 2018. Growth of hypothetical $10,000 invested in the iShares Global Timber & Forestry ETF:
The chart reproduced above illustrates how an investment of $10,000 made in June 2008 when the ETF was launched, would have appreciated in value over the years. The returns assume reinvestment of dividend and capital gains. Fund expenses, including management fees and other expenses, have been deducted. How has the iShares Global Timber & Forestry ETF performed over a longer timeframe? The following performance quoted indicates that it has provided steady returns since its inception, as of March 31, 2018:
|1 year||3 years||5 years||Since inception in 2008|
|Total returns (annualized)||37.8%||14.51%||11.28%||6.99%|
An ETF is a low-cost passive form of investment. Expenses are kept at a minimum by tracking an index instead of conducting expensive research to identify high-yielding investments. The iShares Global Timber & Forestry ETF tracks the S&P Global Timber & Forestry Index. This index currently includes shares of timber companies like:
- Svenska Cellulosa AB – a Swedish timber, pulp and paper manufacturer.
- Rayonier REIT Inc. – a timberland Real Estate Investment Trust with assets located in the United States and New Zealand.
- Weyerhaeuser REIT – an American timber company that has been in existence since 1900.
- West Fraser Timber Ltd – a Canadian integrated wood products company.
- PotlatchDeltic Corp – an American Real Estate Investment Trust with extensive timberland operations.
Investments in shares of timber companies
Timber ETFs like the iShares Global Timber & Forestry ETF can suffer from one drawback. As they invest in a pool of companies, your returns may tend to be lower than if you had invested in a single firm that saw a sharp increase in its stock valuation. Of course, if the share that you buy loses value, your losses could be high. Buying a timber stock is riskier than purchasing a timber ETF. But your returns could be higher as well.
Take the example of an investment in Weyerhaeuser, which is structured as a Real Estate Investment Trust. Here is how its share price has moved in the last five years:
|April 29, 2013||$30.43|
|August 19, 2013||$26.65|
|January 2, 2015||$36.11|
|February 11, 2016||$22.22|
|January 26, 2018||$37.85|
|April 26, 2018||$36.65|
What do these share prices on various dates tell us? If you had bought Weyerhaeuser stock five years ago in April 2013, you would have made a total gain of about 20%. But if you happened to make your purchase two years later in January 2015, your profit would have been negligible. Of course, if you had been lucky and delayed your purchase until February 11, 2016, you would have made a gain of 65% in a little over two years.
Your financial advisor will tell you that buying shares of timber investment companies carries a higher degree of risk than purchasing a timber ETF. Your choice between the two should be based upon your appetite for risk and your ability to tolerate the volatility that individual stocks can exhibit.
Timber investments are not without their share of risks
It is possible that your timber investments can quickly lose value. In that respect, they are like any other form of investment. Timber stocks and timber ETF valuations may decline if the stock market crashes. However, investors with a long-term view could see this as an opportunity to increase their holdings if they think that the intrinsic value of the securities has remained unchanged.
Individual timber investments are subject to risks as well. Consider the issue faced by Weyerhaeuser last year. It seems that the formaldehyde-based product that the company used on some of its wooden I-joists emitted a foul odor. In an SEC filing, Weyerhaeuser said that it would fix the problem at a cost of $225 to $250 million. The issue had also prompted a Philadelphia-based law firm to file proposed class-action lawsuits in six states.
Timber companies also routinely face lawsuits and protests for destroying wildlife and the natural habitat. The Yale Endowment, which owns timberland in New Hampshire’s Great North Woods, has been accused of “… cutting everything, even the growing stock”.
Diversify your portfolio with timber investments
So, is it a good idea to make a timber investment? The answer is a qualified “yes”. You could consider buying timberland directly if you plan to live on the woodlot that you buy or at least propose to visit it frequently. A woodlot of a 100 acres may not provide much of a return, but it is definitely possible to make some money on your investment. Of course, there is also the chance that land values increase in the area. If that happens, you could make a profit if you decide to sell.
However, for most investors, the ETF / stock purchase route is the best way to make a timber investment. This will allow you to diversify your portfolio and earn a dividend income as well. Timber investments may not be very popular, but wood and wood products are highly likely to continue to remain in demand, especially as the housing sector is a major consumer. This will ensure that well-managed timber companies will continue to deliver consistent financial results for many years into the future.
What are your thoughts on timber investments? Do you think that investing in timber is a good idea to gain long-term returns? Or have you even made a timber investment already? Would you prefer direct timber investments or rather invest through REITS or stocks of timber companies? Please let us know your thoughts in the comments below.