What’s the Return on Timber Investments?
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Originally published on July 21, 2022 . This article was edited to meet broker-dealer compliance guidelines in May of 2023.
It may not be the flashiest investment out there, but timberland investments has for several decades now served as a component of pension funds, endowments, and institutional investing strategies.
Just like the trees it grows, timberland is viewed as a long term investment, and it has a history of bringing less volatile returns.
This article examines timberland’s historical return profile and explains how timber’s unique characteristics as a natural resource combine to generate those returns.
- Historical Timberland Risk Vs. Return
- How Timber Investments Generate Returns
- Is Timber a Good Investment?
Historical Timberland Risk Vs. Return
Due to the natural growth of the forest products, timberland has historically produced income with consistency.
Historical returns for direct timber investments have been strong, with the National Council of Real Estate Investment Fiduciaries (NCREIF) claiming annualized total returns of 10.74% for its Timberland Index since the index’s inception in 1987 through the end of 2021.
The bulk of timberland returns have fallen between 2% and 6% per quarter, with an occasional return above this range, and few below. As can be seen from the figure below, a timberland investment has annual return distributions that are peaked and positively skewed, even across major historical market movements.
The information above is for illustrative purposes only and does not represent the results of an investment. You cannot invest directly in an index. Past performance is no guarantee of future results. Source: NCREIF Timberland Property Index. Data reflects the period 1/1/1987-12/31/2021.
This performance is in comparison to many other asset classes that tend to have wider ranges of returns. Based on NCREIF data from 1991-2020, Timberland Investment Resources reports a standard deviation of 6.9% for timberland, as compared to 15.9% for the S&P 500 over the same time period.
The same report finds a Sharpe ratio of 1.03 for timberland, in comparison to 0.76 for the S&P 500. (With Sharpe ratios, which are a common metric investors use to determine the relative risk of an investment, the higher the better.)
That means that while total returns for the S&P 500 exceed those of timberland by a little, its volatility exceeds timber by a lot.
It’s also worth noting that timber investments may be tax advantaged. Because they are typically long term investments, subject to meeting the holding period criteria, they will receive long term capital gains tax treatment rather than be taxed at ordinary income rates.
Please note timberland is considered an alternative asset class. There are differences between private and publicly traded equities included in S&P 500. Risk/reward profile varies significantly and public equities provide liquidity while alternative investments are illiquid with longer time horizon.
How Timber Investments Generate Returns
Timberland investments generate returns for investors through:
- cash flow from tree harvests,
- property resale (capturing the value of the trees plus the underlying land), and
- potential additional non-timber income, e.g., recreational leases.
Generally, the larger the property, the more regular the income from timber sales becomes because the more trees there are available for selective harvest.
There is also potential for price appreciation through:
- active management, which can add some operating expense but often serves to meaningfully improve the growth rates, operability, etc. of a forest and
- real price changes over time due to market forces around wood and land prices.
These factors have the ability to positively impact total investment return.
Biological Growth and In-Growth
Trees grow in volume in terms of board feet due to increases in size, but they also grow into higher-value products as a result of this volume.
- Biological growth is predictable, unidirectional, and independent of economic factors, one reason for historically stable performance of this asset class.
- Ingrowth, or trees’ growth into higher-value products, increases over the course of a tree’s life cycle.
The total return on any investment depends heavily on the price you pay initially. The purchase price for a piece of timberland relates to many factors, including where the forest is in its natural growth cycle. Given the long holding periods associated with timberland investing, overpaying can dramatically impact total investment performance.
Timberland is one of a few assets where value can be created through active management. On-the-ground forestry activities, such as tree selection for planting, stand management, or thinning to enhance timber quality, can add material value to any timberland property.
Timber and Land Price Changes
While volatility in timber prices can be considered a risk in timber investing, when examined over the long run, timber prices have trended above inflation. Land prices are far less volatile, tending to change slowly, and can be seen as a buffer against downside volatility.
Is Timber a Good Investment?
To a large extent, a timberland portfolio can be customized to the investor’s goals. Because timber adds value by adding biomass, landowners and timber managers can harvest selectively as trees mature, or buy and hold on appropriate properties for a return on exit.
That’s why localized timber expertise and experienced asset management is particularly key to timberland investment performance. With managers who know how to
- find a quality timber property within a given region,
- sustainably manage a forest for health and productivity, and
- maximize return potential within the local market,
an investor can build a tailored portfolio that takes advantage of timber’s strengths as an asset. If you’re exploring building a portfolio of timberland as well as other types of agricultural land, take a look at our current offerings.
Data referenced herein is through year end 2021 and is sourced from Ibbotson SBBI and NCREIF, with additional calculations and analysis performed by AcreTrader. Investors cannot invest directly in an index. Sharpe Ratio (Risk-Adjusted Return) is a risk-adjusted return measure calculated using standard deviation and excess return to determine reward per unit of risk. The higher the Sharpe Ratio, the better the historical risk-adjusted performance. Standard Deviation (Risk) is a statistical measure of the historical volatility; the higher the number, the greater the risk.
The above content is not intended to be a comparison between products, but is intended for general, educational and informational purposes only. Any performance noted is historical and there is no guarantee any trends will continue. All investing involves risks, including the complete loss of principal. Diversification does not guarantee a profit or protect against loss in a declining market. It is important for each investor to review their investment objectives, risk tolerance, tax liability and liquidity needs before investing. Investment vehicles have differences in fee structure, risk factors and objectives. Investments are considered speculative, involve a high degree of risk and therefore are not suitable for all investors.
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Timberland investments have historically been a valuable source of consistent returns, portfolio diversification, and inflation hedging.
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