Timberland is an interesting vehicle for investment, as an asset class it has returns of about 7% a year and is an excellent inflation hedge. In addition the land owner has optionality on when to sell, if prices are depressed they can avoid harvesting for a few years and wait for a rebound. When the timber is harvested the sale is considered a long term capital gain (in the US) even if the land owner has owned the land for less than a year. With all these factors timberland seems to be the perfect investment, put all your money in timberland, do a bit of hunting and camping on the land and retire rich.
The problem with that scenario is timberland is a very hard asset to own. The problem is often tracts of land that support timber production are large and aren't easily broken apart. Often pension plans and institutions will buy into a large timber tract and contract for harvesting. There are a few REITs that own land, but none are actual pure plays on land. This leave an investor with an option to either buy land directly which could cause some portfolio management (and time management) problems, or buy through some sort of exchange vehicle.
As I've mentioned earlier I've had my eye open on small plots of land in Pennsylvania, West Virginia, and southern NY for the past few years. I haven't purchased yet for a few reasons, the first is the hands on nature of the investment. I just don't have the time at this point to spend time prepping the land, planting, visiting to make sure everything is ok (i.e. no hunting, no atv trails, no dumping). The second reason is the difficulty with finding the "right" plot. If I buy too big of a plot my portfolio is out of balance, at this point I don't feel like I'm ready to bite off 40 acres of woods. Yet I would need at least 10 acres before I could make any money. The problem with small plots is they are usually viewed as a lot for building instead of raw land for timber. This means that small plots carry prices in the $10k/acre price vs the $1200-1400 going price for timber acreage. Paying anything more than $1400 makes it very difficult to turn a profit. Finding a small plot for a cheap price is difficult, trust me, I've been looking for the past five years. If anyone knows of a 10 acre plot in WV or PA for around $8500 or less, let me know!
So what does a piece of land actually look like? Here is 44.8 acres of land in southern NY for $36k, which comes out to $850/acre; while this is a good deal (includes mineral rights) the problem is the size and maintenance. For anyone with less than a $720k portfolio this piece of land would be a 5% or bigger position size. Maintenance costs would probably be low, but a small continual cost, in addition if the owner doesn't live close there would be travel costs as well.
If you give a small tree 10-15 years to grow they can fetch about $500 for pulp, and mature trees (age 25-30 years) 4-5k an acre at current prices. So at a purchase price of $36k, sitting for 25 years and selling the wood for $225k ends in a return of about 6.7%. Factor in the ability to sell the land for probably close to the purchase price and we have a 7.2% gain over the life of the investment. There is probably also a value to the mineral rights which I'm not including. This is a great number for something completely uncorrelated with the markets.
The downside is an investor now has $36k tied up in Ripley NY, what happens if that plot gets hit by a tree disease, or has the soil go bad, or a multitude of other things? This is a large concentrated risk, and an investor needs to hold for a long time 25-30 years to make a decent return, not something many people have the fortitude to do.
So what's the alternative to owning small plots directly? I found two closed end timber funds that are about as pure play as possible, they both operate in the US but trade on the London Stock Exchange. And as expected for something posted on this blog, both funds are trading at a discount to net asset value.
The table below breaks down each fund:
Buying at the current prices the investor is getting timberland cheaper by buying Phaunos. The caveat with Phaunos is that some of the plots they are a minority holder whereas with Cambium they own the acreage outright.
Phaunos is a bit of a strange fund, the fund trades on the LSE in dollars which is something not all brokers can trade easily.
Owning timber in a fund is a bit different from a direct holding. In a fund the managers are constantly working to manage the land holdings to ensure a return for shareholders. In the direct scenario nature takes it's course and the return materializes as the trees grow and are eventually cut down.
One risk I haven't mentioned yet is the risk that these funds could be a fraud. Recently there was a story of a Chinese timber company Sino-Forest which falsified the size of their land holdings. This could be true with both closed end funds as well, and is most likely the reason for the discount to NCAV.
I enjoyed reading the filings for both companies, but would prefer a direct holding of timber personally. If the land is close enough I can enjoy it while waiting on investment to grow, something I can't do with a fund.
Disclosure: No positions
I enjoyed reading this. The stock market isn't the only place where people should be thinking like rational investors.
ReplyDeleteI think the Chinese timber fraud had more to do with it being a Chinese fraud than a timber company, but I'm no expert.
Andrew,
ReplyDeleteThanks for the compliment. I think most successful businesspeople think like value investors it's just that we have the most exposure to market related individuals, so it's easy to think in market terms. Having an investing mindset can be valuable with any purchase, make sure the price paid is less than the value received.
I agree with you on the fraud aspect, more of a fraud due to the China factor than timber. Additionally a potential investor could do a quick check on some of the fund's US holdings by calling the tax authority where the lands are held and making sure the correct acreage exists. This would probably be a 15-20m check and is easy enough to do, some might even be online. I would think that if all the US holdings checked out the foreign holdings are probably pretty safe as well.
Nate
Nate
ReplyDeleteHow would you out if they exist ?
If websites which websites ?
If phone who do i call and what should i ask ?
Thank you
sorry for the simple questions i never done something like this before
Jason
Jason,
ReplyDeleteIf you're interested in verifying US holdings it should be pretty simple. I'd go through the same process as if I wanted to know the value of my neighbor's house, so...
1) Find where the holdings are located, most of this was in the annual reports. All you really need is the county.
2) Either call the county or visit the county real estate tax website and get the tax assessment for each plot.
3) I'd also double check the zoning and the land use permits.
So what's the purpose of this? If a company claims to have 10,000 acres in Maine, and you call the county in Maine and they have a record of 800 acres you know there's a problem.
This is just some simple leg work that covers a few simple bases. If you're really serious about verification I'd talk to companies that log and see if the fund is a client, or if they're know. You can then take it to the next level and talk to area lumber mills, or even take a visit and count trucks leaving the property during logging season.
I would say that the level of due diligence would depend on the amount of money you're putting in. If you're putting in a small amount or a small portion of your portfolio I'd probably just spot check some properties. If you're putting your life savings into one of these funds I'd be on a plane to see the property in person.
Hope this helps!
Nate
I used to follow POPE and find the management and the valuation quite interesting (I wanted to buy below 24USD), until it started to surge about a year ago.
ReplyDeleteHi
ReplyDeleteThanks for interesting perspective.
How did you calculate the 6.7% return after 25 years?