Additional Timberland Cash Flow Information
Timber income represents a cash flow that can be controlled to a degree. First, timber can be stored on the stump. If markets are bad, the timber harvest can be postponed until a better day. No matter what the markets do, the timber itself will experience biological growth. When timberland is purchased a key component of the investment analysis is the age structure of the stands. When the various stands become mature and ready to harvest will dictate the potential timber harvest timing. Thus timberland cash flows offer both predictability and flexibility.
Stumpage or timber prices are a key determinant of the rate of return earned from timberland investments. Timber price projections are produced by many organizations from Massachusetts-based RISI that since 1985 has developed large-scale econometric models to the USDA Forest Service Research Stations that have developed huge models of the global and national timber economies. Timber products supply and demand determine timber prices. Freshman economics teaches that the intersection of supply and demand will determine price. Factors that are included in these models are world supply and demand conditions and national supply and demand drivers like population change, per capita disposal income, and land use changes.
The United States is the largest producer of industrial timber in the world. For the last 40 years it has produced a stable 25 percent of total global roundwood production. At the same time the United States imports 60 percent more timber products than it exports (in terms of value). The United States has a huge forest resource which explains why it produces so much and it also has a huge domestic economy that explains why it imports so much. The principal destinations for exports are Western Europe, Latin America, and the Caribbean. The regions are experiencing growing populations and economies, and rising demands for southern timber product exports can be expected.
In the United States national forest harvests have declined to small fractions of past harvest levels due to environmental pressures. Nonplantation timberland is projected to decline by 15 percent by 2039 due to urban and residential land uses. The population of the United States is projected to increase by 49 percent over the next 50 years, with average age increasing from 36 to 41 years. This aging population will create increased demands for renewable resources, especially recreation. Per capita income is projected to increase 3 percent annually over the next 50 years. These are just a few of the trends built into the USDA Forest Service timber supply models.
Timber actually represents many forest products. Timber supply and demand models have to account for changes in individual products, between products and technology that can create new products. Differences in tree species and tree types will also affect timber supply and demand. A key consideration is simply whether the tree is a softwood (coniferous tree, usually an evergreen, having needles or scalelike leaves) or a hardwood (usually broad-leaved and deciduous). Markets for softwoods and hardwoods differ markedly. In spite of rising pulpwood production and improvements in product manufacturing efficiency, producers have not been able to increase output as fast as the economy's demands for pulp-based products. In 1953 virtually no residues (wood chips and other wastes) were used in wood products manufactured in the South; panels and pulp were made from roundwood. In 1998, residues accounted for about 29 percent of the volume of both softwood and hardwood fiber received at the gates of pulp mills and composite panel mills.
Hardwoods have captured an increasing share of southern timber production. In 1953 hardwood roundwood was about 12 percent all roundwood harvested, while in 1999 it accounted for 34 percent. Hardwood roundwood nearly tripled in output while softwood roundwood slightly more than doubled. Price changes reflect this: hardwood roundwood prices have increased by two-thirds in real terms (net of inflation) over the period, while softwood prices have increased by about 15 percent.
Another way that producers of timber products in the South have adapted to rising demands, increasingly competitive substitute products and imports, and rising prices is by altering timber processing. Wood is now chipped at satellite locations, sometimes right in the woods. Per unit of volume, moving wood in chipped form is cheaper than moving pulp logs. Many of these wood chips make it to the export market. Another indicator of the effect of changing wood production and manufacturing technology is the rising importance of more highly manufactured timber products. Apparently there is a trend toward concentrating a higher proportion of value added at the point of initial manufacturing. Since the 1950's, the use of wood for fuel, posts, poles, and pilings had declined in favor of wood produced for lumber, paper, and engineered wood.
From 1954 to the present the percentage of wood removed as saw logs has been nearly constant at around 38 percent. Pulpwood has risen from 21 percent to around 40 percent. The proportion of output in the form of the largest and highest quality logs, veneer logs, has trended upward from 3 percent to about 9 percent.
Stumpage prices affect both the income and capital appreciation components of total return on a timberland investment. Besides annual revenues that might produce income (like hunting lease revenue), the main income source is from periodic harvests of the timber. Obviously, the magnitude of stumpage price at the time of periodic harvests dramatically impact income. Likewise, capital appreciation is mainly due to appreciation of the timber. Part of that appreciation results from biological growth, but a large part results from appreciation in timber prices. Thus, timber prices have a huge impact on all aspects of total return.
Land prices for growing timber are obviously related to timber prices. Thus, since timber prices are projected to grow in real terms, likewise land prices should grow. Land prices tend to be correlated with timber prices, with a two to three year lag. Timber Mart-South reports on land prices in the South. Timberland buyers expect a quantity discount when purchasing timberland. Reported prices for land are for properties greater than 5,000 acres and properties of less than 5,000 acres. From 1990 to 2002, for properties of greater than 5,000 acres land price increased from $200 per acre to $385 and for properties of less than 5,000 acres it increased from $350 to $629. That is roughly a 5 percent annual increase. With over 10 million acres of timberland expected to shift to institutional investor hands over the next decade, land price is a major factor in timberland investing.
Forest land is diverted mainly to urbanization and agricultural uses. Additions to forest land occur mainly from conversion of idle cropland or pastureland that is reseeded or replanted to timber. Until 1987 the South annually lost more forest land than it gained. Due mainly to government incentive programs to reforest marginal crop and pastureland, starting in 1987 net forest land actually increased annually. Actually acres of southern timberland (the forest land productive enough to grow timber) are about the same today as they were in 1950. Obviously, marginal agricultural land is physically limited and urbanization is not going to decrease; thus, over the longer term timberland acreage is bound to decrease.
Ownership is likely to continue to change. Forest industry lands should continue to decrease, with much of the land going to institutional investor ownership. This means that the intensively managed industry lands will likely continue to be intensively managed. Nonindustrial private lands owned by individuals are often moving to owners who subdivide or fragment them. Fragmentation leads to smaller forested tracts that lose economies of scale in management. This may lead to less timber production on these lands.
Tree growth follows a sigmoid curve. This means rapid growth occurs at early ages, a point of maximum growth can be easily determined, and growth slows down after this maximum is past. The growth and yield of trees and stands of trees can be accurately predicted using well-established computer models. As trees grow they move into progressively large diameter classes (e.g., an 8-inch tree becomes a 9-inch tree). This is called ingrowth. This is of interest to an investor because 9-inch trees are worth more than 8-inch trees. What is happening is really "product ingrowth." Pulpwood becomes chip-n-saw (large enough to make some lumber and some wood chips). Chip-n-saw becomes sawtimber and sawtimber may move into veneer logs. Biologically, wood is constantly increasing; more importantly value is constantly increasing and periodically value takes quantum leaps as higher product diameters are obtained. As noted earlier a forester controls stocking and thus the mix of products expected from the forest.
Recall that site index (a measure of site productivity) varies and that investors will adjust expected yields and cash flows to account for this. Basically they expect to pay more per acre for higher site index land. Astute investors factor this into negotiations. Also, yields are not limited by traditional site index. Modern intensive forest management practices are now common (e.g., fertilization, herbicide control of vegetation, genetically-improved seedlings) and can expect increases. Depending on the treatments, growth has been shown to increase from 15 percent to nearly 100 percent. Real rates of return for intensive forest management range from 10 to 12 percent. Computer models can account for intensive management and investors are looking at highly predictable situations.
Growth characteristics give investors much flexibility. If markets are currently not good, wood can be stored on the stump and will actually increase due to biological growth. So part of the patient investors rate of return in this situation will be biological growth or a percentage increase on top of expected price increases. Another characteristic is that some stands will be precommercial, but possess high value related to projected future cash flows. For example, a 6-year-old pine plantation has no timber products of value. However, it represents thousands of dollars per acre of cash flow in perhaps 10 to 15 years. Discounted cash flow analysis is used to value such a stand. Astute investors again factor this into negotiations.