The macro-level investment case is strong but buying a grove of teak trees in South America over the internet sounds risky. What are the alternatives?
I’ve been a fan of the wider macro-level investment case for forestry, or timberland, investment for some time. If you’ve read the brochures of companies selling forestry investments in South America or other tropical climes, the returns look very attractive and the macro argument why timber will become a scarcer and more valuable commodity over the coming years seems to make sense. It’s tempting, but, at least from my viewpoint, far far too risky given the fact these companies tend to fall outside of regulatory structures protecting investors and are mainly operated by the kind of sales professionals who switch from investment product to investment product depending on what’s currently in vogue. There have also been well publicised instances where ‘eco friendly’ forestry investment schemes located in the tropics have turned out to be scams, either proven or still ‘allegedly’. Despite all that I still do really like the underlying big picture arguments for forestry investment as an asset class. This article takes a look at whether there are options for private investors on a modest budget to explore direct ownership of a crop of trees that don’t set huge alarm bells ringing and offer a reasonable looking risk profile.
Forestry investment is by its nature a large scale enterprise and as such would seem to exclude the viability of small scale investment. There are a lot of businesses where margins or returns look like they should be attractive in principle but require both large amounts of capital and specific expertise, which must be either possessed or expensively hired to be viable. Building and renting out an attractively located piece of real estate like an office building, for example. For the private investor, unless spectacularly wealthy, the only way to access such asset classes is through a fund of some sort, in which case you add an additional layer, the fund, who naturally also wants an attractive return on investment. You can guarantee that the fund will make sure it makes money for itself which means that the investor will get what’s left when there is plenty to share around. Funds are not known for their frugality in terms of remunerating their employees and their own corporate accounts, so in a pinch, that may not be much, if anything at all. There is of course a place for managed funds and although they get a bit of a bad rap for charging high fees and underperforming, plenty also do well for investors. There are a handful of funds that are focused on forestry investment and timber as a commodity as their underlying asset which I’ll look at in another article but here the focus is on direct ownership options.
The pitch of forestry investment products targeted at private investors is that the investor gets direct ownership of and exposure to the commodity without that additional expensive layer sapping the lion’s share of theoretical returns. ‘You own the trees’. That appeals to many an investor based on the same instinct that means many prefer to own property directly rather than invest in a REIT (real estate investment trust). When you invest in a REIT you don’t need to have a sizeable deposit, take on a mortgage, deal with letting your property or pay someone to do that at significant cost, you spread your risk over the REIT’s portfolio of property and can sell your investment pretty much whenever you want. But the returns are usually much lower due to the aforementioned overheads and the REIT’s value is heavily influenced by general stock market sentiment rather than only the underlying assets’ performance. So while many investors do invest in REITs, many more prefer the direct route of property ownership and buy a buy-to-let property. However, this approach is much less accessible when it comes to forestry investment. As much as it takes time and effort to manage a buy-to-let property most of us probably feel it is within our capabilities to practically do so.
A forest, or even a patch of forest, is a different matter. While trees will just grow if left to their own accord, they won’t do so optimally and would also be at much greater risk of various threats. They need monitored for and protected from disease, parasites, fire, illegal logging etc. They need to be thinned at the right time and in the right way to both ensure optimal growth and provide cash flow. A buyer for the timber harvested from thinning or cutting the trees down when mature needs to be found and the timber must be delivered to the buyer. There may well be more than one buyer as you will have different categories of timber as well as waste wood to be made into chips etc. So unless you plan on spending several years training to become an expert in forest management and getting handy with a chainsaw, you’ll still need paid for services to both nurture, protect and eventually cash in on any forestry investment. Without having done a full-scale investigation (or even a small one to be honest) into the costs, it stands to reason that this will be significantly more expensive when done on a small scale. Like agriculture, commercial forestry is naturally predisposed to scale when it comes to maximising, or even achieving, profitability.
All this would suggest that the private investor should probably forget about direct forestry investment as an option. However, investment vehicles aimed at private investors claim to have surmounted these issues. The argument for this is that they allow numerous private investors to invests in tracts of timberland in one area so their individual plots are collectively managed by a single forestry management company and effectively then have the necessary scale for this expense to be economically viable. The question then becomes ‘how is this that different to a fund’? Someone still has to manage the entire process, so wouldn’t that dilute the investment’s returns in the same way as a fund’s management fees? This is clearly a valid question but let’s start with the assumption that funds have bloated overheads and vehicles offering the kind of vehicle for private investors outlined above are much more streamlined.
So, I’m a private investor, I’ve seen the figures that every company in this space presents in their prospectus. I’ve read the obligatory reference to how much a Harvard University investment vehicle has poured into timberland. I understand that trees take time to grow and land to grow on which is finite and a growing human population and general global living standard means timber supplies are likely to face pressure which will increase prices of the commodity. I accept that timber as a commodity is not strongly correlated to the stock market and the moment of harvest can be delayed while the commodity increases in value if market conditions are not favourable (though you can also hold on to an equities portfolio and wait for better times rather than selling in panic during a downturn, something which seems to be neglected in this particular argument). I understand there are attractive tax breaks associated with forestry and woodland investment. I am at least intrigued to find out more, if not yet convinced. After all, if it was that easy and safe to make 10% compounded return a year on invested capital, why would anyone be fannying around (please excuse the colloquialism) with buy-to-let property and equities portfolios?
Let’s take a look at how forestry investment vehicles marketed directly to private investors, or after a ‘I’m a sophisticated investor’ box has been ticked, are structured. In many cases that I have come across you don’t actually own the land the trees are planted on but lease it or have some kind of ‘rights’ to the timber growing on the land. This is not in itself necessarily a bad thing, many businesses operate in this way. When the return from the activity performed upon the land or what is produced by it, take agriculture for example (and I would consider commercial forestry as a niche of agriculture), is significantly more than the return the land owner makes from renting the land, there is a strong business case to lease land rather than tie up resources acquiring ownership that can instead be invested in the more profitable activity performed on the land. The land owner has a reliable income without taking on the risk or work of production and the producer doesn’t tie up capital in the land, it works out well for both parties. However, not owning the land removes a layer of protection and ‘safety net’ for the investor not without significance when the investment is far away and unlikely to be ever seen in person. The fact of the matter is that the kind of alternative investment that forestry represents is very much reliant on the management of the company behind it.
There are couple of companies currently on the market offering direct forestry investment opportunities located within the EU. A transparent legal structure, company domicile within the UK and timberland holdings close to home which can be easily valued and monitored goes a long way to bringing risk levels within acceptable parameters. One such company is Arden Forestry, which offers direct forestry investment located in the UK and Ireland. In the interest of transparency, it should be noted here that iNVEZZ does have an advertising partnership with Arden, entered into on the basis that we consider Arden to have a good structure as a company and investment product, with the location of forestry plots in the UK and Ireland providing an acceptable degree of security for investors.
Entry level for investment starts at £10, 000 for a 2 acre holding of Sitka Spruce and the land is fully owned by the investor via title deed as well as a timber ownership certificate detailing the amount of timber per acre at the time of acquisition. While Sitka Spruce has a full growth cycle of 30-40 years the company mainly acquires land that has trees that have already reached a minimum maturity of 20 years, meaning investment terms can start from 5 years. One of the main points in favour of the Arden Forestry offering is that UK and Irish forestry investment is exempt from all taxation after a minimum ownership term of 2 years. The company forecasts returns of 23.9% on average over a three year period with income derived from grants which are available during the years before harvesting timber is possible, periodic thinning, and the final harvest of the full timber crop.
Investors are made aware that the investment should be considered illiquid. While investors are free to sell their holdings on the open market, or ask Arden to market it for them, it can be presumed there is not an established open market for such small holdings of forestry land and that the company will most likely prioritise selling new clients new holdings over facilitating a resale market. The lack of liquidity is probably what investors considering forestry investment of this kind should think about most carefully. It looks like an interesting long-term revenue generating physical asset, but not one that should be relied upon for quick sale and conversion into cash if required.
The availability of income from grants before trees are mature enough for thinning, together with the absence of any taxation on forestry investment and the fact that the land and management company are based in the UK and Ireland makes this an alternative investment class that is worth a look. In terms of direct exposure to forestry I haven’t personally seen another product that ticks the ‘acceptable risk’ box in the way Arden’s packaged investment does, as long as liquidity is not a priority.
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