Analyzing Timber Markets for Timberland Investments

This article touches on two areas associated with evaluating local timber that have direct relevance to analyzing timber markets for investment and operational management in the United States: estimating sustainability and distinguishing hardwood markets.

Assessing Forest Sustainability with Growth-to-Drain (GTD) Ratios

Across professions and asset classes, we apply multiple tests to support investment decisions. For example, reliance on a single measure can mislead and, ultimately, confuse. In medicine, a heartbeat confirms life, but tells us little of health. In finance, IRR speaks to the rate of return, but tells us little about the investment required or wealth created. And in assessing local timber markets, the “growth-to-drain” (GTD) ratio provides a snapshot of sustainability, but provides little insight, by itself, regarding the ability to support new wood-using facilities.

We estimate the GTD ratio by dividing growth of the forest (net mortality) by removals (volume harvested) from the forest each year. If the ratio exceeds one, the local market grows more wood in a year than is harvested. If the ratio falls below one, the local market harvests more wood in a year than it grows. We also calculate net growth by subtracting removals from growth to provide an estimate of the “surplus” volume accumulating in the market each year. In the end, net growth, evaluated over time, can trump the GTD ratio for ranking timber markets and wood baskets. Wood-using mills and timber-selling landowners don’t live on a steady diet of ratios, they survive on a steady flow of logs and cash.

Assessing Hardwood Markets

For baseball card collectors, quality trumps volume. The analysis of hardwood markets reveals a similar reality: simply owning lots of trees differs markedly from investing in high quality and valuable species. Our work in the Lake States and Northeast highlights how hardwood log markets have unique issues relative to softwood markets in the South and Pacific Northwest.

For example, the hardwood lumber market has two “personalities”, with the more standardized rail and pallet markets dominating from a volume standpoint and grade lumber affecting realization and profits. According to the Hardwood Market Report, pallets and railway ties comprise ~55% of the U.S. hardwood market. When local markets are short log grade logs, the manufacturers of pallets, rail ties and mats must buy higher grade logs or lumber, or switch species. When compared to softwood markets, hardwood markets are remarkable for their sensitivity to supplies, the common substituting and the price volatility.

Implications for Timberland Investors

Timber market analysis emphasizes local assets, wood flows and cash flows. For examples, while the GTD ratio simplifies the feasibility analysis of local timber markets to a single, easily communicated number, it provides an incomplete story. In addition, the structure and behavior of softwood markets differ markedly from hardwood markets. While both can make attractive timberland investments, they profile and perform differently over time.