In the course of a single day, you probably use forest products considerably more often than you even realize. The most obvious products are newspapers, tissues, checks, wooden furniture and the occasional parking ticket. The least obvious activities that can involve forest products include having your breakfast, taking certain medicines, traveling to work on a bus or in a car and using detergents.

Some 30% of the world's land area is covered in forest - 9.88 billion acres or so. The latest figures from the Food and Agriculture Organization of the United Nations (FAO) indicated that, in 2004 alone, trade in forest product totaled US$327 billion. In context, this amounts to 3.7% of "global trade value of all commodity products."(1)

The FAO's most recent conservative estimate is that trade in wood and wood products will reach some US$450 billion in the international market by 2020.(2) Even back some seven years ago, the USDA Forest Service was projecting that "through 2050, U.S. consumption of forest products would increase 69 percent while U.S. timber harvest would increase 38 percent."(3)

While investing in timber may not be considered, by some, as exciting as investing in nanotechnology, it remains a solid proposition.

Timber: The Investment Proposition

The three most attractive elements of the investment proposition are the following:

1) Timber is a low-risk investment. Over the last 30 years or more, there has been little or no positive correlation between the returns generated from timberland and those from either fixed-income or equity assets. There has, also, been little positive correlation with other assets classes, e.g., private equity and commercial real estate. (4)

2) Timber has, historically, generated significant real returns, including sizable cash yields. Over calendar year 2006, the National Council of Real Estate Investment Fiduciaries Timberland Properties Index returned 13.7%. Over the last 20 years the same index has returned on average more than 15% annually, while the S&P has returned less than 12%.

3) Timber has, over the long term, been a relatively effective hedge against inflation, particularly unexpected inflation.

In addition, an investment in timber is also an investment both in a hard asset and, significantly, in a sustainable and renewable asset.

Ways To Invest In Timber
Private investors own more than 70% (356 million acres) of the 500 million or so acres of commercial timberland in the U.S., with federal, local and state governments holding the vast majority of the rest.

Private investors in timberland have, predominantly, invested through:

• Timber Investment Management Organizations (TIMOs)
• Real Estate Investment Trusts (REITs) and other publicly traded companies
• The Timber ETF
• Direct ownership

Timber Investment Management Organizations (TIMOs)

Of the institutional money (endowments, pension funds, etc.) invested in timberland - well in excess of US$20 billion - the majority is invested through TIMOs.

TIMOs have raised pools of money from both institutional investors and high net worth individuals to buy and manage timberland.

As privately held entities, TIMOs are not traded on any stock exchange and are, thus, in a position to better manage their timber assets to achieve the greatest long-term returns with the least possible risk.

They are, for example, in an excellent position to weather any downturns in the market. If the price offered for their timber is not good enough, they can just leave it "stored on the stump." Left so, it only becomes more valuable as it grows! TIMOs generally do not own manufacturing operations, which would expose them to these kinds of hiccups, but this may be changing: the Forestland Group TIMO recently purchased a sawmill.

There are currently some 20 TIMOs (5) in the U.S., including such well-established asset management firms as Hancock Timber Resource Group, Grantham Mayo, Timbervest and the timber vehicles of big Wall Street firms like UBS.

However, catering as they do to institutional and high net worth clients, not only do they have high minimum investment levels, but many also expect very long-term commitments. (In some cases, this can be as long as 10 years with an option to extend for a further three years thereafter.)

The minimum investment level with some TIMOs can be as low as around US$200,000. Others will even allow individual wealth managers to pool their clients' monies to facilitate investment. On the whole, though, you are looking at some US$2 million to US$5 million for commingled funds and between US$20 million and US$200 million for a separate account. Fees usually run at around 1% per annum, with managers often charging additional performance fees. (6)

Real Estate Investment Trusts (REITs) And Other Publicly Traded Companies

Probably the cheapest and most easily achieved exposure to timber is through investment in a publicly traded vehicle, either a REIT or a traditional company.

There are currently some six publicly traded timberland REITs in the U.S. (7), of which Plum Creek and Rayonier and the largest and second largest respectively. A number of these were originally traditionally structured timberland companies, but converted to REITs, specifically timberland REITs, because of the significant tax advantages this afforded them. One of the greatest tax advantages for a timberland REIT itself is exemption from corporate income tax on its earnings from land holdings.

For investors looking for high dividends and a stable income, REITs are particularly attractive, since they are required by law to distribute at least 90 percent of their taxable income to their shareholders. Traditionally, both Rayonier's and Plum Creek's dividends have been around 4%.

In contrast with TIMOs, timberland REITs are not obliged to remain strictly ‘timberland' and can diversify their operations through alternative land use. This means that REITs such as Plum Creek can be as much real estate investors as they are timber managers. As REITs, they have the ability to develop their land for other uses, as vacation properties, for example, if, as so developed, the value of such land comes to exceed its value as timberland. Or, indeed, they can exploit any other natural resource opportunities, such as through mining, that the same land might offer.

An alternative is an investment in a straight timber company. Like REITs, timber companies have historically paid high dividends, although they are not required to do so. The difference is that timber companies have more discretion to retain assets and invest in growing the business - while REITs are angled directly at high-income and high-dividend payouts.

Although pretty close to pure timber ‘plays', both being publicly traded, REITs and traditional timber companies are always prey not only to the vicissitudes of the stock market, but also to their obligations.

The Timber ETF

As an alternative to either REITs or traditional timber companies, there is one (and perhaps soon more than one) timber ETFs.  The Claymore/Clear Global Timber Index ETF (AMEX: CUT) invests in some 27 companies invested, at least tangentially, in the timber industry.  But the play seems less than pure.  While it does feature companies like Rayonier, who are fundamentally timber companies, it also features more problematic companies like MeadWestVaco. As a major paper producer, they can be hurt by increases in the price of timber as much as helped - it all depends on how well they manage their own portfolio.  So remember, CUT is stock, not wood.

Direct Ownership Of Timberland

And then, of course, there is direct ownership of timberland itself. Even though this might be the purest timber ‘play,' this is an option neither for the fainthearted nor for anyone averse to rolling up his or her sleeves!

Unless you are going to hire either a manager or large institution to oversee your timber from seed to saw bench, you will have your work cut out for you.

In the first place, amongst other things, you will need to decide whether you want to invest in softwood, for example, fir, pines or cedars, or hardwood; for example, oak, maple, cherry or birch.

Are you going to invest in new plantations or, perhaps, in existing natural forest? Although the former have higher levels of productivity, the latter have lower capital and continuing management costs. (8)

And where are you going to invest? Unless you have a very great deal of money, diversification will be a significant problem.

Finally, if you do not think you will lose sleep over the physical risks of fire, wind damage, ice and snow, insect infestation, disease and theft, and can live with the quite significant issues of liquidity risk (your money is going to be tied up for a score of years or more) and supply-and-demand risk and price risk, then direct ownership of timberland may be an option.

If you do decide to go ahead, from a tax point of view, you can benefit both directly, and handsomely. Uniquely for timber as an asset, under federal tax laws, not only is income from harvesting timber treated as a capital gain, but also gains from the sales of timber can be offset by the maximum allowance for depletion, i.e., the annual cost assigned to timber harvested.

The Downside: Is The Timber Trade Crowded?

Timber has become very popular recently, thanks to the huge success institutions like Harvard and Yale have had in investing in the non-correlated asset. In fact, some advisors and analysts think that the timber trade has gotten crowded, sometimes with investors just chasing returns.

Christian Busken at Fund Evaluation Group specifically noted in his interview with HardAssetsInvestor.com that: "Unfortunately, as you've had more institutional investor interest in timber, it has increased competition for deals, increased prices and driven down returns expectations to a certain degree." And Louis Stanasolovich, president and CEO of the Pittsburgh-based Legend Financial Advisors, emphasized in his interview that investing in timber should not be a short-term play, but that "...if you look out 8 to 10 years, it makes a lot of sense."

Conclusion

An investment in timber can help further diversify an already well-mixed portfolio. With its low correlation to most major asset classes, the inclusion of timber can enhance a portfolio's return potential while reducing its volatility.

Historically, timber has proved a good hedge against inflation, particularly unexpected inflation. At the same time, it has provided stable, strong, real returns.

While the returns from timber have, historically, been very high, current expectations are that future returns will decline. In spite of this, however, given timber's unique ability to "grow" on average 6% a year if it's not harvested, timber will continue to provide an opportunity for healthy capital growth with low risk over the long haul.

Next Up: Water

Is water the ultimate commodity? Some people think the answer is yes.

Links For More Information

• http://www.campbellgroup.com/
• http://www.tirllc.com
• http://www.htrg.com
• http://thetimberlandblog.blogspot.com/