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Investing in timber: money does grow on trees after all

So what’s so good about trees? According to Grantham, forestry is the only low-risk, high-return asset there is: it has, he says, risen steadily in price for 200 years and has returned an average of 6.5% a year for the last century. It is also counter cyclical – it has been the only asset class in existence that has risen in three out of the four market collapses of the 20th century, says Grantham. That’s not to say there haven’t been short-term blips in the fortunes of forestry investors. There have.

In the past timber prices had spent more than seven years in freefall, thanks to a flood of cheap imports.

Today real soft timber prices   are still 50% below those of 1996. But that shouldn’t be the case for long. Over the last three years, prices have recovered by around 11% (according to the FIM Timber Index) and that is a trend most experts see continuing. Why? The answer is the usual one: thanks to the rise of the emerging economies and their massive middle class, the supply/ demand balance is working very much in favour of the timber price.

On the supply side, note that deforestation continues apace across the world (one tenth of global forest has disappeared in the last 25 years, due to urban development, agriculture and illegal logging), while in eastern Europe all the easy-to-get trees have already come down and the cost of transporting what remains has gone up substantially (fuel and freight prices have both risen in the last few years). The days of cheap imports are all but over. Indeed, says FIM, not only are the usual suppliers not exporting like they used to, but they are seeing shortages at home: Scandinavian firms are having to turn to Russia to top up their own supplies.
Why timber prices will continue to rise

Still, it is not so much tightening supply in Europe that is set to keep prices rising, it is that global demand for timber is rising fast. Take China. On current forecasts, its urban population will increase from 530 million people to 875 million people by 2030. To house them, the equivalent of almost 50 cities the size of greater London will have to be built over the next 20 years. That’s going to need a lot of timber. And wood is needed for every stage of development all over Asia. Let’s not forget that the paperless office never happened. In every office around the world, everyone who wants to read something properly prints it out. As China and India grow, that’s going to mean a lot more paper.

But Asia’s new middle classes are also going to want new furniture, more books, daily newspapers, delivery pallets and Christmas wrapping paper (apparently much of China does celebrate Christmas). Chinese lumber consumption doubled between 2000 and 2003, and its demand is forecast (by the WWF) to grow 30% in the next five years. Add it all up, says FIM, and global forecast demand is “equivalent to finding another source of supply of timber with five times the output of the UK each and every year”.
Why forestry will benefit from green energy demand

There’s another reason why demand for wood will keep rising – the nation’s new obsession with green energy. The largest sustainable energy supply  comes not from wind power, but from biofuels. And one of the best biofuels is wood, burnt as pellets or chips (wood is a renewable source of energy that creates little polluting waste). It is a fast-expanding sector: there are bio-energy projects that would use 3.6 million tonnes of wood fibre a year at “feasibility stage” and three of these have received planning permission, or are already under construction. The result? There is now a demand for low-quality timber in quantities that simply didn’t exist a few years ago. Biomass demand should entirely replace the demand lost to recycling, for example. All in all, says Angus MacDonald, “the macro issues look right” for timber prices and hence for investing in forestry.

Over the last few years the price of forest plots has become slightly separated from the price of timber. In some cases, prices have risen to levels that cannot be justified by the potential returns from timber sales. Valuing woodlands used to be easy: you looked at how much money you were going to make from growing and selling your timber, applied the appropriate discount rate and that was that – the result showed you what the woodland was worth.

But today, people are paying more in the expectation of making large capital gains from the land itself, or just for the satisfaction of owning land. This is something that has already happened in the agricultural land sector and that shows no sign of coming to an end. So why should woodland be any different?
Other advantages of forestry: tax breaks and carbon credits

It’s all sounding good, isn’t it? But there’s more. First, there is tax: there is no income, capital gains or inheritance tax on woodland (see the box below for details). And finally, there is the prospect of finding ways of making secondary cash flows from the land. At one of Macdonald’s forests there is a possibility that the Forestry Commission will pay to move timber through from their adjoining land, and there is always the chance of getting paid to have mobile-phone masts on your site.

But what is really getting the pound signs flashing in foresters’ eyes is the carbon-emissions business. There are endless arguments about whether planting a tree counts as a carbon offset (ie, can it compensate for the emissions you produce by driving your child to school in a Porsche Cayenne?). Sceptics point out that trees lock up carbon only when they are alive (cut them down and it’s released again) and WWF, Friends of the Earth and Greenpeace all say they “do not support forestry projects to offset carbon emissions”, according to The Guardian.

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