Timber : A Recession Proof Investment Class ?
Like the search for The Holy Grail, private as well as institutional investors are looking more than ever for an investment which will hold its own during times of market turmoil and downsizing, and whilst gold & other key commodities indeed look like a good investment these days, few seem to have discovered “The Holy Grail of Investment”.
This post, however, identifies one such and the keyword is Forest Land and Timber.
Larry Light of WSJ says in his recent article on the subject of timberland investment, that timber seems to be the ultimate long-term investment and elaborates :
Through Sept. 30, the value of timberland rose 5%. When the National Council of Real Estate Investment Fiduciaries reports 2008’s final quarter this week, this number is unlikely to move much. That marks a slower pace of growth, yet it is growth nonetheless. In 2007, timber appreciation was a towering 15%.
How can positive returns exist in these dark days of shrunken prices for everything ranging from real estate to commodities to stocks? Oil, after a summer price spike, was down 54% in 2008, while corn lost 11% and copper 54%. (Gold, as a refuge commodity, rose 6%.) Prices for lumber, a key forest product, have fallen by 34% over the past year as housing construction has ebbed.
The answer to this riddle is that timberland is the ultimate long-term investment, with relatively little bought and sold each year — and demand still respectable for what does change hands. “As long as the sun shines, the trees will grow,” says Jeremy Grantham, chairman of Boston money manager GMO and a long-time fan of timber investing. “Timber will never be an orphan.”
He goes on to say that whilst timber does generate decent cash returns year on year, the long term dividends is where the real value and ROI lies :
Timber often is likened to high-grade bonds, meant to be held for 10 years or more. The average annual timberland appreciation for the past decade is 4.1% versus minus 3.8% for the Standard & Poor’s-500 stock index. The timberland appreciation figure, which encompasses both the land and the trees, is based on sales and appraisals. After 10 or 15 years, investors cash out when the land is sold.
On top of the appreciation, timber generates regular income. Trees are constantly chopped down and sold for everything from boards to paper mulch, albeit in smaller volumes these days. Cash returns from this “harvesting,” as it’s called, are now 1.5% of the property value, down from 3% in 2007 and about 5% annually the three years before that.
He does, however, also mention that one of few downsides on timber investments is the fact that timber is rather illiquid and also that one needs to have substantial amounts of cash to get in :
“Trees keep growing 4% per year, no matter what happens to inflation, interest rates or market trends,” says Dennis Moon, head of U.S. Trust’s group overseeing timberland, as well as farm and mineral investments. “You don’t have to cut them down this year if that doesn’t make sense.”
On the downside is that, as the ultimate long-term investment, timber is very illiquid. Looking to park your kid’s college tuition someplace for eight years? Forget wood. Plus, timber’s cost of entry is dauntingly high. The best returns, adjusted for risk, come from large, multimillion-dollar partnerships called timber-investment management organizations, or TIMOs, sponsored by the likes of GMO and U.S. Trust. But these require a minimum $250,000 investment, and often many times that.
TIMOs’ overhead can be onerous, too: They may charge from 3% to 5% per year in assets for property management, taxes and insurance.
A cheaper way of investing in timber is via several real-estate investment trusts. Most prominent is Plum Creek TimberCo., the largest private land holder in the U.S. Investors can get in for around $32 per share. Over the past 52 weeks, its price has fallen 26%, better than the S&P 500’s 37% drop. Indeed, Plum Creek’s showing is better than the S&P paper and forest product index, which has slid 50%. The index is focused on board-making companies like Weyerhaeuser, whose fortunes are more closely tied to the housing industry, rather than the slow-growing majesty of a maple.
Chris Mayer of Capital & Crisis also highlights the flexible nature of timber as an investment :
Timberland is a crisis-proof investment because the growth of the trees does not move in step with economic cycles. You don’t have to harvest when demand is soft. Let them grow, and trees will become more valuable anyway. Bigger trees equal more dollars.
Timberland as a timely and crisis-friendly investment might seem odd, given its ties to the housing market. In fact, demand for timber as a building material is weak right now, at least in the U.S.
As the housing market reaches depths not seen in a long time, the end of the deflating housing bubble seems a ways off. Housing inventory in the U.S. at the end of June was 4.9 million homes, or about 12 months of supply – a glut we have not seen since 1981. New housing starts are near 17-year lows. And perhaps most surprisingly, even though housing prices have fallen quite a bit already, there is probably plenty of room to go, based on at least one good historical indicator: price to income.
Mayer explains in detail why it is that despite a weakening housing market globally and no sign of a quick recovery either, timberland value continues to climb :
There are three reasons for this, all making timberland a good investment today. They are scarcity, global demand, and institutional interest. Let’s take a look at each of them…
Growing scarcity of quality of timberlands. The mountain pine beetle infestation had a very real effect on supply. North America will lose about 20% of its spruce, pine, and fir lumber over the next five to eight years. In addition, much of Canada’s boreal forests are not economical, thanks to high costs and Canadian taxes, unless lumber prices rise significantly. Many of these businesses have already shut down.
Also, the U.S. government continues to set aside timberland for conservation – about 1.4 million acres per year. Add up all three, and you have a good case for tight supply.
The other big issue outside of North America is the reduction in Russian logs. Traditionally, Russia has been the low-cost provider of timber, but log export taxes have taken much of its timber off the global market. So as Russian logs withdrew, prices skyrocketed in markets in which Russia was a key supplier. In the frosty Baltic states, for example, lumber prices recently hit 18-year highs. Softwood prices were 57% higher than a year ago.
Global demand should increase. China is a giant here. It is the world’s largest importer of logs. Its appetite has increased 16-fold in the last 12 years alone! As the Chinese build more homes, they’ll need plenty of lumber.
In addition to China, the demand for biofuels has an impact on timberland. The use of wood pellets and cellulosic ethanol for fuel, for example, provides a source of growing demand for wood products. Wood is environmentally friendly, which could become more important as we get into reducing carbon emissions.
Growing institutional interest in timberland. There is a big slug of money in institutional vaults – like pension funds – slated for investment in timberland. By some estimates, there is at least $10 billion in funds seeking timberland investments. All the usual appeal of timberland – steady inflation-beating returns – has caught the interest of these whales. This provides a floor of demand for timberland.
These three factors keep timberland prices strong, even as housing markets stay weak. There is one other interesting point… Lumber has not yet really joined in the commodity cycle. Its pricing lags that of many other commodities.
Lumber pricing lags even competing building materials. The gap among lumber prices and concrete and steel, for example, is as wide as it’s been in 20 years. So timberland – an increasingly scarce resource – ought to participate sooner or later.
So if one assumes and believes that the above three factors remain in play, and this seems likely, timberland should prove to be a gem amongst the many asset classes the investor is considering so maybe it is time to plant a forest somewhere on Mother Earth and harvest the yield in years to come ! Who said eco-friendly investments cannot be the best ?