In times of economic uncertainty, asset diversification within an investment portfolio can provide a hedge against market drops as well as protection against inflation. Usually, this means a distribution of assets composed of stocks, bonds, and perhaps precious metals. One asset that can diversify a portfolio but does not get a lot of attention is timber. From 1993 to 2017, timberland produced average returns of 8.36 percent. Not quite as high as the S&P 500 of 9.69 percent, but as an alternative for diversification purposes, respectable — outperforming government bonds and Treasury bills.

Lumber caught everyone’s attention this past year as prices more than doubled due to the frenzy in homebuilding and renovations spurred on by low interest rates and government infusion of dollars into the economy. Sawmills were in an enviable position of having an oversupply of raw product at low prices and a seemingly unquenchable demand for lumber products. A lot has changed since then; interest rates and inflation have gone up and lumber prices have come back down but are still high by historical standards.

This past year was an anomaly with wild fluctuations and volatility, which is usually not the case. Timber and lumber prices have a history of appreciating over time and are not directly linked to market influences that usually affect stocks and bonds. Timber (raw stumpage) prices are not always linked to lumber prices, which was the case this past year. Basically a person can invest in timber in two ways: as a timberland owner and as an investor in lumber company stocks, Exchange Traded Funds, or Real Estate Investment Trusts.

Land Ownership

There are very few investments that a person can actually enjoy. Stocks and bonds are no more than numbers on a digital screen, but owning timber and the land it occupies can be immensely rewarding if you enjoy the outdoors. And in contrast to many popular beliefs about the timber industry, it is actually a wonderful way to support the environment as most areas planted in trees growing for the purposes of paper or lumber would be agricultural fields planted in row crops otherwise. Once timber reaches maturity, a new crop of trees is replanted, effectively keeping more land covered in trees absorbing carbon dioxide.

Trade-offs come with everything, and owning timber as a pure investment play will probably not meet expectations. Dr. Adam Kantrovich, Clemson Extension specialist of agribusiness, says, “If a person has property that is not being farmed or used for other purposes, then it makes sense to have timber and a timber management plan as this may allow for reduced property taxes and provide income through periodic harvests. But if the objective truly is for investment with the only concern the return on investment, careful consideration should take place.”

He further explains, “Timber is a long-term investment, and it is difficult to determine how good or how poor of an investment it will be 20 to 40 years down the road.”

Currently, a glut of southern pine is on the market, which has kept stumpage prices down since 2008. This glut may take several years before reduction in inventories occurs and prices rise. Also present is the inherent risk of timber damage before harvest from insects, disease, storms, or fire, but these risks are quite low at 0.5 percent/year from natural disasters and 0.3 percent/year from insects, according to Hancock Timber Resource Group.

Brent Keefer, chief executive officer of American Forest Management, Inc., is optimistic on the long-term potential for timber in South Carolina and the Southeast in general. “Strong fundamentals continue for all parts of the forest products sector. Demand for housing remains strong, which in turn drives the demand for lumber and panels. I’m bullish on the long-term outlook. The shift of lumber production to the South from both the U.S. West and Canada will continue,” he says. “The oversupply of timber in the South that has persisted since the great financial crisis of 2008-09 will gradually come back to being more in balance with demand, and timber prices will slowly and steadily improve over the long term.”

Timber appreciates in two ways: growth and price. For the first 15 years, loblolly pine, which is the predominant tree planted in the South for timber, is too small to be sold. While it has no market value, it does retain intrinsic value as it grows. Once it reaches approximately 7 inches in diameter, which takes about 15 years, it has reached its first product class as pulpwood. Pulpwood is used to make paper, and at this age a first thinning takes place that will generate revenue and will improve the growth of the remaining trees by reducing competition.

Approximately five years later, many of these remaining trees will move up to another product class and a higher value known as chip-n-saw. A chip-n-saw tree is in the 10- to 15-inch diameter size. At this time, the timber owner will have the option of conducting a second thinning that will produce more revenue and will again benefit the remaining trees by removing competition.

A chip-n-saw log is used for both pulp and small dimension lumber. At age 30, the remaining stand has now grown to greater than 15 inches in diameter and has become sawlogs. Sawlogs become lumber and demand the highest value of the three product classes. At this size and age, they are traditionally clear-cut to reap maximum value, and then the site is replanted for another 30-year rotation.

As Dr. Kantrovich relates, other factors should be considered by the potential timberland owner. “Besides the timber itself, the land that sits below is also an investment and should be given consideration as well. Also some new market possibilities are beginning to emerge that may help with some income such as the carbon credit market. Although at this stage it is a young emerging market that still needs to mature a bit, with some additional policy and regulation to stabilize and set some minimum standards, this may benefit landowners and others in the future.”

As a form of mitigation, carbon credits allow a company, such as an energy utility, to purchase credits to offset carbon emissions. Growing timber, which sequesters carbon, can provide those credits. The timber owner agrees not to cut the timber over a certain period of time in return for cash payments.

Brent’s perspective is similar. “It is hard to be definitive at this point if carbon credits will become a viable revenue stream for timberland owners. What I do know for sure is that the interest in forests as natural climate solutions is real and growing. Significant capital is available from very large institutions and very large corporations that have made net zero commitments, and they are looking to forestry offsets to help provide a piece of their emissions offsetting strategy.”

Anyone contemplating becoming a timberland owner should meet with a forestry consultant to go over the costs and potential returns a particular tract of land may produce.

Stocks, Funds, and Trusts

Timber ETFs are comprised of companies that produce timber or timber-related products. By investing in a timber ETF, an investor has liquidity unlike a timberland owner. IShares Global Timber & Forestry ETF invests in 25 timber companies. Another is MSCI Global Timber ETF that invests in 81 timber related companies. IShares Global is the larger of the two with approximately $320 million in assets that seek to track the S&P Global Timber & Forestry Index. Since its inception in 2008, it has had an average annual return of 6.47 percent.

REITs invest in real estate that produce income and are required to pay out most of that income in the form of dividends to investors. Timber REITs, unlike most REITs, have a manufacturing component due to their investment in wood product companies. Timber REITs benefit from increased residential homebuilding through the manufacture of lumber as well as the selling of timber. Four timber REITs are available from which to choose, two of which are with companies that own timberland and manufacture wood products.

As Brent explains, “ETFs and REITs offer exposure to timberland through the public equities market. Generally speaking, these investments do reflect the market drivers of the forest products sector; however, they also tend to be correlated with the broader public equities market. ETFs and REITs offer easy access and liquidity but also tend to have more volatility as compared to direct timberland investment. Direct timberland investment though is harder to access and is illiquid.”

Investing in timber by owning the trees yourself or indirectly through the equity market provides a different asset class to the investor that can provide stability, growth, and diversification. Unlike some newer type investments such as crypto, the timber industry is well established and an integral component of our economy although one in which many private investors do not participate.

Despite the old saying, money really does grow on trees.