Kurt Akers
12/01/2003
Institutional investors have been adding timberland to their investment portfolios for the last 20 years. But the poor performance of the stock markets in recent years has further spurred these investors to seek alternative investments to diversify their portfolios, including hedge funds, real estate, and timberland. Among these safe harbors, timber in particular has proven a valuable port of call.
Institutions are not the only group that can benefit from the sheltering shade of timberland investment. Given the flurry of activity in timberland markets over the past several years, many individuals have begun to recognize the benefits as well.What makes this "old economy" commodity such an attractive investment opportunity is not merely its historically strong returns (low double-digits over the past 15 years), but an assortment of unique characteristics:
Low correlation with stocks and bonds – Timber prices do not track those of stocks and bonds. Likewise, the biologic growth of the trees has no relationship to the gyrations of the stock market or interest rates. The result? A portfolio that contains timberland is able to generate higher returns with lower risk than a portfolio that does not.
Strong and flexible cash flows – Timberland investments have historically generated cash yields higher than the dividend rate for the stock market, while continuing to appreciate in value. Because biologic growth continues to occur regardless of the market environment, timberland owners have the ability to reduce cash flow in times of unfavorable pricing and to generate higher cash flows if the need arises.
Environmental considerations – Investors who actively manage their timberland properties provide habitat for wildlife and protect important environmental values. Many properties have unique characteristics that can be preserved through conservation easements and other programs.
Beyond these distinguishing factors, the tax treatment of timberland benefits non-institutional investors. Timber that is harvested and sold is treated as a capital gain as opposed to ordinary income, which gives this commodity an advantage over other types of investments.
Several avenues exist for an individual who wants to invest in timber. One is to buy shares in forest product companies that own large amounts of timberland. However, these companies typically own material amounts of other assets that tend to dilute or negate the attributes of timber. Pure-play timberland entities also have been introduced in tax-favored forms such as the REIT or master limited partnership, with one—Plum Creek Timber—having a large enough market capitalization to be included in the S&P 500.
Another method is to simply purchase raw timberland directly. While many investors find this option personally appealing, the high cost of a timberland property often prevents obtaining enough to gain an appropriate level of diversification that would prevent exposure to a single market or to biological and natural disaster risks.
As a third option, investors can participate in products offered by a timberland investment management organization, or TIMO. TIMOs allow you to pool resources with like-minded investors to develop a diversified timber portfolio. This avenue gives the individual investor a more direct voice in the strategy and management of the fund while preserving the tax benefits of timber. The surge in institutional assets has nourished a number of qualified TIMOs, each with a unique strategy or approach that offers potential investors numerous choices of professional investment managers.
The timing for investing in timber also is favorable. After peaking in the late 1990s, timber markets have been soft for several years due to a strong U.S. dollar, surges in imports, and heavy sales of properties by large forest product companies attempting to streamline their businesses. As the dollar weakened and imports slowed, factors favoring investment have become more prominent. With strong demand for housing expected to persist well into the future, long-term timberland investments are expected to perform well.
 | Kurt Akers is director of research with Global Forest Partners. |