Investing in forestry warrants serious consideration. Historically attractive long-run returns relative to other investment classes, low volatility and high correlation with inflation, make a forestry investment a good inflationary hedge. Investing in forestry can help to bring balance and stability to an investment portfolio otherwise biased towards financial securities (such as equities and gold) offering the prospect of higher returns but carrying the risk of greater price fluctuation. In this guide we take a look at the options available to investors considering exposure to this alternative investment class.
Forests or Forestry Products?
A basic decision the investor needs to make is whether the investment is directed towards a real estate investment in forestry– timberland and timber – or to the downstream production of forestry products. Of course, the two enterprises may be vertically integrated, with the forest owner also operating a timber mill, for example, or a pulp mill. We’ll look at such integrated operations below, in the context of indirect investments such as equities and funds, but for now we consider direct forestry investments in either a standing forest or in the establishment of a new forest.
Direct Forest Acquisition
Generally speaking, the purchase of a forest, or an area of forest, for income generation will require a significant outlay in the United Kingdom and other developed countries. Allowing for the costs of husbanding and harvesting trees, the likelihood of restrictions on the quantity – percentage-wise – of trees which can be harvested, and in all probability a replanting obligation, the purchase of a small tract – say five to 10 acres – will not translate into meaningful income. At best, the purchase should be seen as an investment in a lifestyle or amenity choice, albeit with the possibility of a capital gain on a future sale.
For income generation, something appreciably larger will be needed – in the order of, say, 100 – 200 acres. But even then, the traditional income stream from forest ownership – the sale of timber – has over the past two decades shrunk dramatically as a rate of return on the purchase price of the land.
This phenomenon of ever rising prices for timberland has been observed in many parts of the developed countries where forests – hitherto owned by vertically-integrated forest products companies – have since the 1980s been divested onto the open market. Simply put, forests have become available for purchase by anyone with the necessary funds and demand is no longer driven solely – or even at all – by the harvestable timber on the land. Today other drivers are in play. A given tract of forest may represent a ‘kingdom lot’ – the personal playground of a wealthy individual, an item in a hedge fund’s land-bank, a speculative play by a property developer, or the destination of conservation funding expended by a government or ‘green’ organisation.
Nevertheless, direct forestry investments remains viable for the individual private investor. At the time of writing, for example, a large tract – over 110 acres – of mixed deciduous and coniferous forest just outside the M25 south of London was on the market for £395,000. At around £3,300 per acre, this is top-end pricing – in more remote parts of the UK, mature timberland can be had for much less. A stand of 187 acres primarily coniferous in north Wales, planted in 1983 and five-10 years away from mature harvesting, is currently on the market at just over £1,300 per acre.
An attractive feature direct forestry investments in a number of countries is the favourable taxation treatment afforded by governments keen to encourage woodland conservation. Thus, for example, inheritance tax in the UK is waived on forests owned for more than two years at the time of death, there is no income tax on timber sales and capital gains tax is limited to the value of the underlying woodland and does not extend to the growing timber.
But unless the investor has particular experience of managing a forest, an ongoing cost which needs to be factored into a forestry investment is the engagement of such expertise. Whether or not the standing timber is the rationale behind the investment, careful husbandry of the forest will enhance both investment and amenity value. Especially at the time of purchase, the investor will need an impartial expert assessment of the stand and its future value in harvestable timber and other forest products. Such objectivity is unlikely to come from the seller or the seller’s agent.
Syndicated Forestry Investments
For most investors seeking a ‘direct’ forestry investment, the more realistic option is likely to be by way of participation in a forestry syndicate. There may be the opportunity to buy into an existing syndicate, where an existing investor is seeking to exit, for example, or where fresh capital is being raised for expansion, but more likely is the establishment of a new syndicate to fund the establishment of a new tract of forest.
Such syndication opportunities are offered in a number of countries worldwide – offerings in the United Kingdom, Canada, Australia, New Zealand and Brazil can easily be found on the internet – and tend to take the same basic form. Typically, they will be ‘limited’ partnerships established under local law to afford limited liability, meaning that the exposure of any given investor to the debts of the venture are limited to the amount of capital paid in by that investor. In this important respect, limited partnerships are like companies. Whereas tax-wise, the income – and, more relevantly, the expenditures – of the syndicate is treated as that of the individual investors, pro rata to their amount of investment. Where local laws so permit, the ability to offset forest establishment expenses against income from other sources makes such investment in a forestry project attractive from a tax-planning perspective.
Invariably, a forestry syndicate will consist of the investors as ‘limited’ partners and a management company as the ‘general’ partner. This company will be set up by the syndicate promoter and will be contractually entitled to annual management and other fees. A prospective investor investing in forestry through a syndicate needs to keep in mind that ongoing fees may be the promoter’s primary financial incentive in establishing the syndicate. In this regard, the promotion of the syndicate may or may not be regulated by domestic securities law, requiring a prospectus, minimum levels of disclosure, and so on. As a general observation, and whereas compliance with securities law is of itself no guarantee of success for the new syndicate, prospective investors in forestry syndicates should be wary of new ventures promoted outside a securities law regime, for example the FSA in the UK, especially one featuring ‘broad-brush’ claims as to future income, liquidity of the investment, and the like.
Another danger is that the manager or broker’s main financial incentive is a fat commission on the sale of the tracts of woodland themselves. This will both eat into future capital gains and potentially leave little incentive for the management to ensure the future success of the ongoing operational returns from timber sale. An independent valuation on the proposed sale price of the woodland as well as thorough vetting of the management company’s background is to be advised. The legal structure of any syndicate must also be carefully evaluated. Many companies online offer forestry investments where the investor ‘leases’ land in various exotic locations around the globe with the expectation that returns will be afforded by the future sale of the timber. Such a structure sets our alarm bells ringing as to the protection afforded to investors and extreme caution would be urged.
On the point of the liquidity of a forestry investments – anyone considering investing in forestry needs to understand that the investment will in all probability be highly illiquid. Meaning of course that, should the need arise to extract the investment funds at short notice, there is unlikely to be a ready – or indeed any – buyer. Some syndicate promoters offer access to a ‘secondary market’ for shares in syndicated forests but this is unlikely at any given point in time to provide other than a very small pool of prospective purchasers, none of whom may be willing to pay the exiting investor’s price.
The point here is that an investment in forestry should be seen as long-term. Trees take a long time to grow to maturity – hardwoods such as oak need more than a hundred years and softwoods (typically pine) between 25 and 40 years. Even timber grown for bio-fuel production – willow and certain eucalyptus, for example – are five-10 year investment projects. An investment in a syndicated forest plantation should be entered into only on the assumption that the funds will remain committed to the venture until harvesting and sale of the timber, even if an earlier exit proves to be a viable option.
Shares in Forestry Investment Companies
For the prospective forestry investor seeking appreciable liquidity in the investment, it’s necessary to look to exchange-traded securities in either dedicated woodland owning, forest product companies or in holdings which include forestry and/or forest-generated products amongst other enterprises.
Until the 1980s, forest products companies were pretty clearly delineated as such. They were typically vertically integrated, with ownership of every aspect of the business of growing, harvesting, processing and supplying timber products. But the ‘neo-liberal’ economic policies introduced in developed countries from the mid-1980s – now synonymous with ‘Reaganomics’ in the United States and ‘Thatcherism’ in the UK – saw wholesale restructuring in the forestry sector with, especially, the divestment of forests, the outsourcing of logging operations and a concentration on core milling and processing activity. Impacts on traditional forest products markets – notably the ongoing decline in demand for newsprint since the emergence of the Internet – have driven investment in new technologies and uses for wood products. Not all of that investment has proved to be productive.
A by-product of these processes has been the emergence of a wide range of forestry-related enterprises and the development of investment activities and strategies far beyond traditional stakes in listed forest products companies. Now, the challenge in front of the prospective forest sector investor is making the decision on which type of forestry investment product to run with.
Investing in forestry funds which have an experienced management team is one clear way to access exposure to forestry investments. Although more liquid than physically investing in forestry assets as private investor funds do usually have a period of at least three years, though it can be much more depending on the fund’s strategy, during which any funds which you invest will be tied in. Certain funds have clear exit options after shorter periods of time, and most will offer your stake for resale, however they do not provide full liquidity. Another disadvantage of forestry funds, and funds in general, is that the minimum entry investment level can be high and more targeted at institutional and high net worth investors than retail investors. There are however funds which do offer smaller entry level options specifically targeted at the retail investor market.
If liquidity of the investment remains the principal or a high priority, the basic choice lies in either publicly-traded REITs – real estate investment trusts – or in timber-related ETFs – exchange-traded funds. ETFs and REITs consist of shares traded on either mainstream or secondary stock exchanges in different parts of the world. REITs will typically hold pure woodland assets whereas ETFs may hold both physical timber as a commodity, woodland and upstream and downstream forestry-related businesses. The advantage and weakness of exchange traded investments is that though their value is influenced by the value of the underlying assets it can also vary considerably due to the strength or weakness of the equity markets. This means that when the market is strong any increase in the value of the underlying asset may be reflected more strongly in the market price of the tradable units ie. due to demand they may rise by a greater percentage. Inversely however, when the market is weak and demand on equity markets is not there, the price of the exchange traded units may be significantly poorer than the underlying value of the assets held would suggest it should be.
The prospective investor would do well to find out exactly what the REIT or fund has invested in and what its investment strategy is going forward. If a ‘pure-play’ forestry investment is sought, with no exposure to downstream manufacturing, the field will narrow considerably. Yet there remain publicly-traded equity securities in companies in the United States, the UK and elsewhere which are more or less totally focused on the acquisition or establishment of woodlands and the harvesting and sale of their primary products – logs.
Investing in forestry will basically take the form of a direct solo acquisition of a tract of forest, participation in a syndicated project or the acquisition of some form of share in a publicly-traded investment vehicle. To all intents and purposes, going it alone is not a realistic option where income generation is driving the investment unless the forest is of big enough size to produce meaningful income – which will be beyond the resources of most private investors – and there is professional forest management in place.
Syndicated forestry investment ventures open up the field to the private investor but need to be approached in a level-headed way, with due regard to the promoter’s financial incentive and the integrity of the investment proposal.
Neither of these mechanisms allows for ease of liquidating the investment, should that become necessary. For that purpose, the focus must shift to an exchange-traded security.
Whatever vehicle is chosen, anyone considering investing in forestry needs to educate themselves on exactly what it is they’re buying into and of course the rationale for the investment, given alternative destinations for the investment funds.