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Back to the Future with Timber Investment Management Organizations

Investing in Timber: Timber Investment Management Organizations Maintain Markets

By Matthew Harrison
Date Posted: 10/1/2006


       In 1985 a DeLorean automobile captivated audiences around the country as Marty McFly breached the space-time continuum on the big screen in Back to the Future. While moviegoers became enamored with the exotic, gull-wing automobile, investors found new ways to immerse themselves in an old source of revenue with high earnings potential: private forest land.

      As McFly quickly came to understand in the movie, history frequently reveals much about the future. During the 1980s, a handful of investors abandoned economic theory for the sake of tried and true renewable natural resources. In 1985, only $69 million was invested in private forest land. Now, timber investment management organizations (TIMOs) have over $15 billion invested in timber.

      These organizations are maintaining markets in areas of the country where private forest ownership surpasses government-owned forests. TIMOs are spreading across the northeast, southeast, and beginning to emerge in the northwest, where federal land management has hampered logging for the past decade. Most TIMOs are created to either supplement or replace corporate pension funds because of their potential for low-risk, high profit returns.

      Much like Doc Brown’s sleek, stainless steel DeLorean time machine, TIMOs are engineered for performance.

      Over the last 40 years, a good timber portfolio could net annual returns of 13%-15%, exceedingly better than that of S&P 500 investments, which typically yield about 11% annually.

      While critics are quick to cite unexpected risks — such as wildfires and other natural disasters — as reasons for caution, a closer inspection indicates that wildfires impact less than 0.5% of privately-owned forests per year.

      The success of TIMOs has made it easier for small investors to snare a piece of the pie, which has caused a recent flourish in the market. While initial investments used to be in the millions of dollars, customers can break into the market with as little as $250,000 or even $100,000 depending on the company. Individuals are using TIMOs to supplement their 401k retirement plans in order to establish a financial safeguard. Timber investments also tend to do best when stocks and bonds decline, making it a good counterweight in a balanced portfolio.

      TIMOs enable investors to capitalize on harvests in 10, 15 or 20 year cycles. Smaller southeast pines, for instance, can be harvested and sold after 10 years to pulp and paper mills, but waiting a full 20 years allows investors to take advantage of medium-diameter harvests that produce lumber for commercial and residential construction.

      One of the TIMO giants is the Campbell Group. Based in Portland, Ore., the Campbell Group holds $1.36 billion worth of forest land, primarily in the Pacific Northwest but also with holdings in the southeast.

      “Investors may be looking for real returns, meaning an inflation hedging type of asset and a real asset class — something like real estate, something that’s there and solid,” said Angie Davis, the Campbell Group’s director of business development. “It’s not synthetic or it’s not a stock or a bond.”

Trapped in History? 

      Since TIMOs provide a continuous supply of work, loggers spend more time in the field making money. However, as McFly found in Back to the Future, even the flawless engineering of a DeLorean can leave one stranded in an unfamiliar period. Luckily, McFly found a younger Doc Brown who was able to remedy a broken flux capacitator with the help of a convenient lightening strike.

      For TIMO managers, their financial safeguard is the ability to sell land for development in order to satisfy concerned shareholders. Meanwhile, loggers could catch the stinky end of the stick and become economically stranded in their own right.

      “Institutional investors have one mandate, and that is to earn returns for their beneficiaries,” Davis acknowledged. “So if you have a significant return built into your portfolio, it may be best for their beneficiaries to realize that gain and reinvest that money in something else.” TIMOs typically sell land when the gain is substantially higher than future timber production cash flows.

      “I don’t see a long term sustainable benefit from TIMOs in the future,” agreed Bob Simpson, vice president of forestry for the American Forest Foundation. “It’s in their short ownership horizon. Most of them have a 12 to 15 year horizon, and that is not sustainable.”

      A recent study by the U.S. Forest Service estimates that about 15 million acres of private forest land have been developed for housing or business use since 1984. Furthermore, the study predicts that by 2030, an additional 44.2 million acres of forest land will be sold for development.

      Development revenues do not figure into most TIMO plans, though. George Dutrow of the Forestland Group, which manages 1.6 million acres across 16 states, thinks selling off valuable land assets would be counterintuitive. “What we are focused on is to achieve an eight percent rate of return.” Investors seem happiest as long as the income keeps coming. Furthermore, investors are mindful of the 10-20 year harvest cycles, meaning that their money is devoted to TIMOs for the long haul.

      Charlie Tarver, president and ceo of Forest Investment Associates, is not concerned with the hype surrounding development sales. “A lot of people like to talk about land development,” Tarver remarked. “[But] out of 10,000 acres, for example, that you might have in somebody’s portfolio, you might find a few hundred that you’re able to sell off.” Only a slight minority of TIMO land is ever sold, he suggested.

      In addition, TIMO land sales are not necessarily for development projects, Tarver noted. “It may be that the adjoining land owner really wants the property, and they are willing to pay a price that is substantially above fair market value for a timber tract,” Tarver said. “I think most TIMOs have a policy of being willing to sell small parcels like that when you have the opportunity — and yes, you seek those out. In the big scheme of things, it’s a relatively small percentage of the overall portfolio.”

      “A typical client might have several hundred thousand acres scattered over several different states,” Tarver continued, who noted the benefits of such geographic diversification. “You really don’t want all of the investment to be in one locale; you want a shield against physical risks and market risks.”

      This diversification strategy benefits loggers and foresters in more of the non-traditional timber markets by spreading logging potential and land management across the country. Dutrow said that the Forestland Group typically relies on single bidders for timber harvests while frequently signing long-term contracts with remote sawmills to help keep rural economies bustling.

      The TIMO trend is working to appease conservationists while also maintaining forest ecosystems. Investors do not look kindly upon dying timber; so many TIMOs are heavily vested in forest stewardship programs. The Forestland Group and the Campbell Group both implement rigorous stewardship programs that cater to the unique and biologically diverse nature of each timber tract. TIMOs use internal and external forest management certification systems, such as the Sustainable Forest Initiative (SFI) and the Forest Stewardship Council (FSC).

      “Our standards are developed by a broad multi-stakeholder engagement process,” said Roger Dower, president of the U.S. FSC. “Environmental organizations, companies, and social community organizations are who we bring together to help design and set standards.” FSC protocols require third-party inspections for logging, land usage, and even more intricate details of forest management, such as using pesticides.

      “The jury is still out,” said Dower. “This is a new, evolving ownership pattern. How TIMOs will participate in certification and industry trade associations, I think, is still hard to predict.”

      The Forestland Group has already met FSC requirements while FIA and the Campbell Group similarly claim to meet SFI standards. Other TIMOs, including Hancock Land Company, Molpus Timberlands Management, and Timbervest are following suit, keeping timber’s ecological future syncopated with a history of investment prosperity.

      With housing starts hitting a 13-month low at 3.8% below 2005 levels and demand for lumber on the decline, some analysts wonder if timber investments will sustain their success.

      According to Davis, peculiar, even paradoxical market conditions leave TIMO returns unscathed. “TIMOs typically derive income from managing the forest,” she said, “harvesting the trees, and selling the logs — not on the lumber side. One would think that they are correlated, and eventually the mill owners will pass their decline in lumber prices by bidding less on logs, but it just hasn’t happened.”

      TIMOs are riding out success at 88 miles per hour, creating a new wave of financial sustainability. Forestry professionals still have their doubts, but even Simpson conceded that at the very least, “the only thing TIMOs can do is give a 12 year guarantee to those companies who have sold their ownership and are looking for fiber supply,” thus providing loggers with work in the foreseeable future.


 






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