Thursday, February 21, 2008

Can money grow on trees?

I was researching alternative assets classes that not only could perform as well as the stock market but also provide good diversification opportunities as well as passive income possibility. One asset class which seems a little overlooked is timber.
According to several websites that I found, investing in timber has beaten the stock market by 4 percentage points from 1973-2003.

There are several advantages of investing in timber:

  • Timber is uncorrelated to stocks
  • The price of timber has consistently beaten inflation by 3.3% over the past decades
  • Unlike other commodities, trees grow every year by 4% - 10% and as they age their wood becomes more valuable
  • Even if prices decline, you can decide not to cut your trees in a given period. Your trees would be growing no matter what you decide to do with them.
  • You get certain tax breaks – your profit is taxed as a capital gain. On top of that, as timber is cut, another tax break called a depletion allowance kicks in.
  • You could invest in timber REIT’s, like PCL and RYN, which are publicly traded on NYSE
  • The Food and Agricultural Organization of the United Nations forecasts that world demand for wood will nearly double by the middle of this century.
  • The USDA-Forest Service projects that demand for U.S. forest products will reach 25 billion cubic feet annually by 2050, up from nearly 18 billion in the 1990s.

There are several disadvantages of investing in timber as well though

  • Most direct timber investment is limited to wealthy individuals who can chip in at least $1,000,000 to $5,000,000.
  • Timber Investment Management Organizations typically require a ten year lock up period to their investors
  • Timber Investment Management Organizations typically charge hedge fund like fees of 1% on all the assets invested plus 20% of the annual profits. It seems like you do need some managing of your forests in order to maintain them.
  • Trees could be subject to fires. 0.5% of all trees suffer from this
  • Trees could suffer from disease’s, so one should spread their timberland holdings across the globe
  • Timber investments have soared form 1 billion in 1989 to more than 20 billion by 2005. Seems like the market is getting crowded.
  • Even though timber investments have provided investors with 22% annual returns on average form 1987-1996, the returns have dropped to 8 % over the past decade
  • Demand for timber is subject to cyclical swings in the economy. If housing starts plummet or manufacturers need less cardboard, then prices could plummet.

    You could find more information about investing in timber under the following links below:

Investment University , Financial Planning , MSNBC, Tropical Hardwoods( I am not sure if this last link is the real deal or not, so please use with caution)

My financial resources are still less than 1 to 5 million in order to invest directly in timber. For diversification purposes though, I am considering investing in RYN or PCL. Stay tuned for my analysis of these two companies.

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