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The difficulty of investing in timber [ClearOnMoney]
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The difficulty of investing in timber

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Commentary

The difficulty of investing in timber

13 Apr 2012 by Jim Fickett.

I haven't yet found an attractive timber investment. The difficulties are laid out below. Suggestions on other places to look would be appreciated.

I would very much like to invest about 5% of the portfolio in a chunk of forest. This would be in the boring-but-solid, set-it-and-forget-it half of the portfolio. I would not be looking for capital appreciation, but rather would view the investment as rather like TIPS – inflation adjusted principle (a forest should, properly maintained, keep its real value) plus a regular dividend, as the trees grow and are harvested. Given that philosophy, I'd like to buy when timberland is reasonably valued from a long-term perspective (see Trees are at fair value), and I'd like to see a sustainable dividend yield in the range of 2-3%.

It's easier said than done.

It is convenient these days that one can bet on a sector via an ETF. But the two timber-related ETFs (WOOD and CUT) are not really timber investments:

J. Brian Fiacco, owner of Timberlands Strategies in Summerville, S.C., advises institutional investors on timber purchases, and has concluded that E.T.F.’s are not an accurate proxy for timberland. Too many of the companies that they hold no longer own much, if any, actual timber, he said. Consider International Paper, whose shares are owned by both iShares and Claymore Beacon. It sold the bulk of its timberland to focus on manufacturing, he said.

The most obvious way to get into a timber investment, if one is willing to choose individual stocks, is via a timberland REIT. There are four of them. On a first look, some time ago, my initial impression was

  • Weyerhauser – Unfunded retirement obligations look like a big problem.
  • Rayonier – Solid company, but not really a timber investment; most of the income is from manufacturing, not logs.
  • Plum Creek – Opaque structure, with subsidiaries that are not included in consolidated financial statements; very difficult to estimate their real income and cash flow.
  • Potlatch – None of the above problems, perhaps interesting.

So I recently took a closer look at Potlatch. In one post last year (The threat from the mountain pine beetle) I worried about the impact the mountain pine beetle might have on Potlatch forests, so I asked their investor relations department about this. They said that the MPB attacks mainly lodgepole pine, and their holdings include almost no lodgepole pine. This doesn't completely take care of the issue, as they do have some ponderosa pine, which is also vulnerable, but it does turn out that most of their trees in the area of the epidemic are not pine of any sort.

That took care of one issue but there is a more serious one: the company is using very deceptive cash flow accounting, and is paying a dividend it cannot really afford. More specifically, they attempt to show that their dividend is affordable by calculating Funds Available for Distribution (FAD), basically free cash flow in the context of a REIT. However when one looks into the details in the annual reports, it turns out that the cash outflow for large land purchases is not counted in their FAD, while the cash inflow when lands are sold is counted. Calculating a true free cash flow shows that the generous dividend (currently 4.1%) is probably half a return of capital, and company is slowly liquidating.

What other options are there? In the US, timber investment management organizations, TIMOs, will take your money, directly buy forest, and manage it for you. TIMOs are big business, managing more forest than the above four REITs combined. However they are not available to the average investor – the minimum investment is typically at least a million, and often several million dollars.

One idea I find attractive is to find a piece of land to live on that includes a few acres of forest, and use wood to heat with (for some background data see Sustainable firewood). Depending on one's investable assets, and the location and desirability of the land, this might or might not be a significant chunk of one's portfolio. And harvesting, chopping, and drying the wood yourself is a lot of work. But it would, in the long run, cut one's exposure to fossil fuels significantly, which might be valuable if we really are somewhere near peak oil.

It might be possible to own a relatively small parcel of forest as a direct investment. From the same article quoted above:

INSTEAD, he advocates the old-fashioned path of just buying timberland. That’s more expensive and time-consuming than buying a security, but may not be out of reach for some affluent people. “You can own small tracts,” he said. “I have 58 acres right outside of Charleston. I also own 150 acres in the northern Adirondacks.”

It seems to me this option requires a significant commitment to learning about forestry and making sure that one hires competent people to help manage the land and interact with loggers. But it is an interesting idea to cut out the middleman and own the trees directly.

So I have four options on my current list

  • Take another look at Plum Creek, which is a very popular investment; perhaps there is some way to come to a real valuation.
  • Look at Pope MLP; this does seem to be a pure timberland investment; the price is probably high right now, but perhaps it would be a good buy sometime down the road.
  • Start looking into forestry companies in Canada.
  • Learn more about whether a direct investment is really practical.

Any other ideas?