Investments: Timberland
Timberland
is defined as land that can be used to grow timber of merchantable quality
and quantity and where timber production is not barred by legal or
regulatory rules. About two-thirds of the nation's forest lands—505 million
acres—is considered timberland. Relative proximity to timber consumers—most
often pulp and lumber mills—is
a key consideration affecting the value of timberland due to the reduced
transportation costs of the cut timber. Another factor affecting value is
the location of the timberland; areas with more rain will experience faster
growth
Federal, state and local governments own approximately 30 percent of U.S.
timberland, or about 154 million acres. The remaining 70 percent, owned by
private entities and individuals, includes timber REITs as well as other
timber investment management organizations. However, the large owners still
represent less than 10 percent of privately held timberland. (Plum Creek,
which owns approximately 8.2 million acres, is the largest private landowner
in the United States.)
Returns and Risks
Timberland is an attractive investment for long-term holders, such as pension
funds, because the "timber crop" is renewable, with cut trees
being replaced by
new growth. So-called "biological growth" is fairly predictable, although it
varies by species and region. For example, timber in the western United
States grows an average 2.4 percent a year, while northern timber grows at
3.4 percent and southern timber at 6 percent. By one estimate, biological
growth is the most important factor in generating returns on investment,
accounting for between 50 and 70 percent of total return.
The major physical risk to timberland is destruction from fire, pests and
disease. Overall, the risk is minimal, accounting by one estimate for losses
of less than one-half percent per year. The primary economic risk in
timberland investment is that prices are highly volatile. If prices are at a
low point when timber is harvested, anticipated profits may not be realized.
Offsetting this is the option to hold off timber sales until prices improve;
in effect, timber can be "stored" on the stump.
Timber REITs
In recent years, the traditional forest and paper product corporations have
become vertically integrated, owning everything from the raw timber to the
manufactured assets—wood, pulp and paper mills. However, says Moody's
Investors Service, while vertical integration is advantageous from the
perspective of controlling the entire process, the ownership of the raw
timber can result in uncertain cash flows that will affect a public
company's stock price. As a result, many companies have sought to decouple
timber ownership from the manufacturing business—a key factor in the
evolution of pure timberland companies, including REITs. In addition, when
timberlands are the sole asset of a company, investors are likely to benefit
from a sharper focus on the land itself with no management concerns
regarding the manufacturing process.
Moody's says that timberlands have the following attractions from an
investment perspective:
-
they are fungible (essentially similar) assets and are increasingly liquid
-
they have a low return correlation to fixed-income investments and real estate
-
they offer capital preservation against inflation
-
they tend to grow in value rather than depreciate
Another factor favoring timberland REITs is
the possibility of higher dividends, especially when compared to integrated
forest product companies.
Tax Benefits
As with traditional real estate, standing timber and timberland is a capital
asset. Thus the usual rules relating to capital gain and loss apply to sales
and exchange of timber. In addition, a timber owner's opportunity for
capital gain treatment is significantly expanded by Code Section 631 to
include the sale or exchange of cut timber. Thus the owner of timber or the
holder of a contract to cut timber can elect to treat the cutting of the
timber as a sale or exchange, whether the timber is held for sale or use in
a trade or business, provided the timber or the contract has been owned for
more than one year.
Furthermore, the disposition of timber pursuant to a contract under which
the taxpayer retains an economic interest in the timber is treated as a sale
or exchange if the timber was held for more than one year. In effect,
Section 631 permits the portion of a taxpayer's gain attributable to the
natural growth of the timber to qualify for capital gain treatment even if
the taxpayer cuts the timber and holds it for sale in the ordinary course of
business.
Real Estate Focus is provided by Somerset’s Real Estate Team for our clients and other interested persons upon request. Since technical information is presented in generalized fashion, no final conclusion on these topics should be made without further review. For additional information on the issues discussed, please contact Michael Fritton, CPA. Whether you are a building owner, building manager, real estate developer, real estate professional, or an investor, we hope to provide you with timely information so you may be proactive in making your business decisions.
This article was written by and published herein with the permission from professionals of BDO Seidman, LLP. Anthony La Malfa is a manager in the Real Estate & Hospitality Services Group in BDO Seidman's New York office. Somerset is a member of the BDO Seidman Alliance, a nationwide association of independently owned accounting and consulting firms.
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