The following article (which appears on the JP Morgan website) was written by Jeff Mortimer, Vice President and Senior Consultant within the J.P. Morgan Investment Analytics & Consulting group.

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BACKGROUND

Prior to 1980, most Timberland properties were owned by integrated forest product companies. These firms, such as International Paper, Weyerhaeuser and Georgia-Pacific, not only owned the physical land and timber, but also the processing facilities – sawmills, paper mills and pulp mills. As a result of tax law changes and prodding from Wall Street to become more efficient, forest product companies began to sell their Timberland properties and focus on their core operations. The passage of ERISA in 1973 gave pension funds the green light to diversify their investments out of traditional fixed income assets into equities and alternative investments. Institutional interest in timber started to gain traction during the 1980s once new organizations emerged to manage the mass of timber investments now on the market. These firms, known as timber investment management organizations or TIMOs, became a significant factor in enabling investor access to “pure” plays in timber.

There are approximately 20 TIMOs in existence today in the United States, and they control roughly $50 billion in Timberland properties. TIMOs are usually structured as public or private REITs, master limited partnerships, limited liability companies or limited partnerships.

Institutions invest with TIMOs via commingled vehicles or through a separate account, depending on the size of the investment. In the case of a commingled fund, a group of investors is formed and a fund is launched. Capital is called as investments are made. Unlike private equity, Timberland investments may generate immediate cash flows in the early years.

Investments in timber are most often characterized by product and location. From a product standpoint, there are hardwoods and softwoods. Hardwoods are deciduous trees that lose their leaves during the autumn season. These trees tend to grow in the naturally regenerating forests of the northeastern and northwestern United States. Hardwoods cater to higher niche markets, such as flooring and furniture. Softwoods are evergreens and typically grow in the southern portion of the U.S. in plantation settings. The majority of large Timberland owners, both in the U.S. and internationally, focus on plantation softwoods. The end use of softwoods is structural lumber.

Categorizing timber by location typically begins by differentiating investments based on geography - U.S. vs. international. Russia, South Africa, and Central and South America are classified as developing markets. Unlike relatively low risk investments in North America, political and currency risks emerge when dealing in these markets.

SOURCES OF Timberland RETURNS

In order to understand a Timberland investment, it is important to understand the fundamental components that comprise returns. Timberland returns are driven by the following three factors. The first factor is biological tree growth. Timber is a renewable resource and, if managed well, will increase in value as it matures. Trees not only grow in volume, but they also turn into higher value products as they grow. This nonfinancial source of return is unique to the Timberland asset class in that growth occurs regardless of macroeconomic conditions or financial market performance. There are not many assets or investments that can make this claim. According to research compiled by the International Woodland Company (IWC), biological tree growth accounts for approximately 65%-75% of the Timberland return.

The second factor is timber price change due to macroeconomic factors such as population growth, construction activity, interest rates and the overall level of economic activity. Unlike most other commodities, timber does not need to be harvested at the end of a growing season. If the price of timber is down, it can be “stored on the stump” and will continue to grow and increase in value. It does not cost extra to store since warehousing costs do not enter into the equation. By taking advantage of positive market conditions, management can maximize the return from the investment, which in turn contributes to lower volatility. IWC estimates that timber price change accounts for approximately 25%-30% of the Timberland return.

The third factor is changes in land value. Most often, the value of the land represents a very small portion (2%-5%) of the total Timberland investment value, so it typically contributes least to Timberland return. Land value is based on more of a supply-demand dynamic than is timber.

An additional but non-fundamental Timberland return source includes easements. Timber or conservation-related easements are financial agreements designed to keep a portion of a forest untouched. For example, a conservation easement results in a property owner transferring some ownership rights to a government agency or nonprofit land trust in return for cash or tax benefits.

LOW VOLATILITY

In relation to Timberland's rate of return, the volatility is low. As noted earlier, the low volatility is attributable to biological tree growth. When Timberland is combined into a diversified portfolio, returns tend to smooth over time, thereby reducing the overall portfolio's risk level.

DIVERSIFICATION BENEFITS

In addition to attractive risk-adjusted returns and low volatility, Timberland investments enjoy low correlations with other asset classes. Combining Timberland into a well diversified portfolio leads to a more efficient portfolio (higher return, lower risk). There is a slight negative correlation between Timberland returns and inflation. This should not be surprising, since inflation has been trending downward for much of the period under review. However, if longer time periods are reviewed, there is clearly a positive correlation to inflation. Therefore, this indicates to a certain extent that Timberland investments provide a hedge against inflation.

RISKS

Despite favorable return and diversification benefits of Timberland investments, there are still risks to consider.

First, there are economic risks since pulp and lumber prices are impacted by the laws of supply and demand, as well as cyclical and seasonal fluctuations. For example, if the economy is in a major downturn or recession, timber demand for new and existing home construction will slow, thus providing downward pressure on lumber prices. This risk is somewhat muted because of the ability to “store on the stump” and harvest when prices trend upward. TIMOs that are structured as private REITs can clearly take advantage of this by adopting a long-term investment approach. On the other hand, publicly structured REITs cannot fully take advantage because they are managing to dividend targets. By definition, publicly traded REITs are required to pay out approximately 90% of their income each year.

Second, there are physical risks, including fire, weather, insects and disease. These risks vary to a large extent across geographic regions and climates. Surprisingly, the total loss for managed forests in the Unites States is fairly low – less than one half of 1% per year.

Third, there is risk due to the lack of liquidity. Timberland is a relatively illiquid investment and is therefore not efficiently priced in the marketplace. A major concern for investors is the risk of overestimating inventory and future growth from a piece of land. The fact that typical investments can exceed ten-year investment horizons highlights the importance of the due diligence process and proper pricing of properties.

Fourth, there is risk due to environmental action. For example, in the early 1990s, the United States government placed certain harvesting restrictions on Timberland in an effort to protect threatened or endangered species. Environmental restrictions – as well as the loss of land to development pressures – will reduce the availability of global timber.

CONCLUSION

In our view, institutional investors should consider an allocation to Timberland. Despite the potential risks, Timberland provides traditional equity returns with fixed income volatility. The diversification benefits are equally impressive.

The focus of most plan sponsors today is on the funded status of their pension plans. Timberland funds typically require a ten-to fifteen-year investment horizon, which makes them an attractive asset to match the long-term nature of pension liabilities and endowment and foundation spending requirements.

Future demand for timber is projected to be favorable due to population growth and improved living standards worldwide. Timberland supply, on the other hand, is finite, thereby preventing overcapacity in the market. This demand-supply imbalance would appear to provide pricing support for the foreseeable future.

I don't think it comes as a surprise to anyone that land is a great investment, but for most people all they hear about land investment is what they hear from some Real Estate GURU with a pitch about how to get rich quick with residential real estate.  All the gurus make it sound so easy.

But do you really want that?

The headaches of buying houses, dealing with contractors in some never ending rehab operation, then trying to find tenants……then dealing with all the problems……broken water pipes…..busted water heaters……clogged toilets.  Do you really want all of this while you work your regular job?  Who’s got the time and patience for that?

Be honest.  Do you get up every morning thinking how great it would be to be a landlord?

Me either.

Well, I’ve got news for you…..The Rockefellers didn’t build their wealth buying dumpy houses in run down neighborhoods.  They built their wealth by buying Jekyll Island.  They bought land…….raw land…….unimproved property…..timberland......land was an investment!

Land Investment . . . yeah, Investment!

Timberland (as an asset class) outperformed the S&P 500 during the big stock market run up from 1987 – 2007?  During that time the only investments that beat timberland were venture capital and private equity.  And because timberland is generally counter-cyclical to the stock market, timberland has held steady while banks, car companies, retail, and the insurance industries have all taken it on the chin.

When you hear about real estate bubble bursting….

Do you ever hear anyone mention land investment, like timberland or hobbyfarms?  Ever wonder why?  I’ll tell you why.  There was never a land bubble and there was never a burst......Only average annual compounded returns of nearly 13%!

Here's something to think about.

In my home state of Georgia, Talbot County is one of the larger counties as measured by area or size.  The population is about 7500 people.  It is very rural with almost no industry.  But 15 years ago you could have invested in land for $400 per acre.  Today, land is going for $3000 per acre.

$20,000 in land investment then….would be worth $150,000 today.  That’s a 650% gain in only 15 years!  In fact, you could have financed it at 9% and made payments of $200 per month.....And STILL recognized a 317% gain.

What’s so special about Talbot County, Georgia?  What's different now?

NOTHING!

And I’ll bet there is a Talbot County in your state, with similar stories from people who took advantage of the land investment opportunity.

So….What’s holding you back?

Here are some additional articles that talk about land as an investment:

• How to Make Money With Rural Properties An Interview with Allen . - The two hottest trends being seen right now are recreational buyers purchasing and developers purchasing. The recreational buyers are purchasing both to hold long term instead of putting money into the stock market, and to reinvest a previous property's proceeds that they've sold. The developers are purchasing because of the demand for country living that has risen and because of cities expanding into rural areas.
• Consider a Land Investment if You're After High Returns | Business ... - The value of land has been soaring over the years thus making it a highly profitable investment alternative. Because land is a finite commodity,
• Field Guide to Land Investment - While land investment may not provide the instant gratification of a home purchase, this sort of venture can be quite lucrative. Land investors have different needs and concerns than those of typical real estate investors - zoning, ...
• » Georgia Species: Wildlife Photography Georgia Country Blog: All ... - Here at at Georgia Country we are a blog devoted to land and land ownership. Any good outdoorsman must be familiar with the species indigenous to their area. In that regard we here at Georgia Country work hard to try to catalog the various species in our region.
• Should Timber Investments Be Part of Your Portfolio by Grant Glessing - Timber and timberland have traditionally been investment vehicles for institutional investors because of the amount of capital required. There are however, excellent opportunities in today's timber and timberland investment marketplace ...
• Invest to beat inflation | Alternative Haven - How to beat inflation in the long run? Historically, there are 2 main ways to beat inflation: precious metals like Gold and Silver and for those who can afford.