By Dr. Jack Lutz,
Principle, Forest Research Group

Private investors have been looking at gold and other alternatives to the tumultuous stock market.

Recently many have started looking where the endowments and family offices have found high returns: the forests. Billions of dollars have been invested in timberland by institutional and high-net worth investors over the past 20 years. By some measures, returns have outpaced stocks and other financial assets. Timberland has been touted as an inflation hedge and as a good asset to use in diversifying a portfolio.

NCREIF Timberland Index

The primary source of information on timberland returns is the Timberland Index published by the National Council of Real Estate Investment Fiduciaries (NCREIF). The Index reports returns back to 1987, with subregion returns reported for the US South, Pacific Northwest and Northeast. The returns for the Timberland Index-US and the S&P 500 are shown in Figure 1. While the index accounts for about $12 billion of investments in the US, we estimate that the value of privately-held, investment-grade timberland in the world is at least $135 billion.

Figure 1. Returns for Timberland and Stocks, 1987-2007

Sources: National Council of Real Estate Investment Fiduciaries and Morningstar

The NCREIF returns in Figure 1 indicate that timberland returns are not what they used to be, but then, returns aren't what they used to be for most asset classes.

Figure 2 compares returns from a number of asset classes over three time periods: the first NCREIF Timberland Index decade (1987-1996), the second NCREIF "decade" (1997-2007), and the NCREIF life (1997-2007). Commercial real estate has done much better in the most recent decade but everything else has returned less over the last decade than it did over the previous decade.

Figure 2. Returns for Various Asset Classes, 1987-1996, 1987-2007 and 1997-2007

Sources: National Council of Real Estate Investment Fiduciaries, Morningstar

Figure 3 shows correlation coefficients for the asset classes from Figure 2 since 1987. Timberland is often described as being negatively correlated with stocks and bonds. However, our analysis indicates that timberland is not correlated (neither positively nor negatively correlated) with most other assets. Different analysis periods produce different correlation coefficients.

Figure 3. Correlation with Timberland, 1987-2007

Sources: National Council of Real Estate Investment Fiduciaries, Morningstar

Inflation Hedge

Timberland is often described as an inflation hedge and the correlation between the two is usually cited as proof. (In fact, the literature indicates that timberland is a hedge against unexpected levels of inflation.) Over the period 1987-2007, the correlation coefficient for timberland and the consumer price index is 0.45. Inflation in the United States has been positive since 1987 and timberland returns have usually been positive. This does not necessarily indicate a cause and effect: since both series are generally positive, they are likely to be highly correlated simply because calculating a correlation coefficient from two positive data series would often yield a positive correlation coefficient.

Investing in Timberland

Timberland investors in the United States can choose private equity investment through many different Timberland Investment Management Organizations (TIMOs) or three (currently) publicly-traded timberland Real Estate Investment Trusts (REITs) and some private REITs. The REITs usually convey the idea that they are an alternative to private equity investment in timberland, and note particularly that investments in a timberland REIT are more liquid than a private equity investment in timberland. We suggest that they are not an alternative: your portfolio might benefit from one or the other or both. The characteristics of timberland as a private equity investment differ from those of timberland in a REIT.

TIMOs have been marketing the benefits of private equity investments in timberland for institutional investors in the United States for over twenty years. Individuals and small partnerships have been pushing timberland investments for wealthy individuals for much longer than that. One of the perceived disadvantages in private equity timberland investment is a lack of liquidity. The liquidity issue has two pieces: the investment vehicle and the underlying asset.

Some investments are through commingled funds which have finite life spans. It is very difficult to get out of such an investment before the end of the term, and it is very difficult to extend the life of the investment if things are going well. But this is illiquidity based on the investment vehicle, not the underlying asset. One way of getting around the finite life of a commingled fund investment vehicle is to invest via a separate account. A separate account has no termination date: investors can sell whenever they want (or buy whenever they want).

Both commingled funds and separate account investments are subject to the other timberland liquidity issue. It takes time to sell a sizeable timberland property. It took International Paper most of a year to sell off 6.5 million acres in 2006. But that year does not include the time International Paper spent deciding how and when to sell, setting up the sale and finding investment bankers to help. Even smaller sales of "only" tens of thousands of acres or hectares can take a year from the time the decision is made to sell until the deal is closed.

The liquidity problem is alleviated by REIT ownership of timberland. Investors can sell shares of the timber REIT at any time. It is certainly easier, quicker and cheaper to sell a few hundred REIT shares than it is to sell a few acres of a privately held timberland. It is also easier to buy a few hundred REIT shares than it is to add a few acres of timberland to an existing investment.

Data history on publicly-traded timber REITs is limited (Figure 4). Plum Creek converted to a REIT in 1999, Rayonier in 2004 and Potlatch in 2006. The return shown in the chart is a market value-weighted return, where the 2006 market value for each company is used for all years. Table 1 shows that, over the nine years of available data, the REITs had higher returns and higher volatility than the TIMOs, and the two asset classes were very poorly correlated.

Figure 4. Timberland REIT and Private Equity Investment Returns

Sources: National Council of Real Estate Investment Fiduciaries, Morningstar and Forest Research Group

Table 1. Return Statistics for Timberland REITs and Private Equity Timberland Investments, 1999 - 2007

Sources: National Council of Real Estate Investment Fiduciaries, Morningstar and Forest Research Group

A Final Word

Timberland is an asset class whose popularity has increased sharply in this century, but it is fairly illiquid when privately held. REITs offer a more liquid investment vehicle for smaller investors, but the investment return characteristics are not the same as those of a private investment.