How Do Timberland Investors Think About Risk and Discount Rates?

Years ago, a forest industry executive told me, “You only get to cut a tree once.” He made the point that, “our trees are in the ground already. So, how do we maximize the value of the forests we have?” That conversation, nearly 20 years ago, has a different flavor today as timberland investors consider forest carbon opportunities, supply chain disruptions and macroeconomic uncertainties.

With that in mind, recent discussions with institutional investors and timber executives have touched on themes and concerns relevant to forest owners and to topics covered in our Applied Forest Finance workshops.

Discount Rates

One timberland CFO said, “when people start talking about ‘real discount rates’, the number they share often conveys less information than the speaker or hearer intends.” This issue aggravates timberland appraisers and investors alike. Even if all parties in the room agree, “let’s apply a real discount rate of X%”, the actual application requires that we confirm cost assumptions, timber price appreciation rates and land values over time.

That said, what have we observed with real discounts applied to timberland investments over the past twenty years? In the early 2000’s, real discount rates declined from around 7% in 2000-2001 to around 6% in 2005-2006 before stepping down to 4-5% in 2007-2008. Following the Great Recession of 2007-2009, rates rose to and above 6% by 2010. More recently, over the past several years, real rates in the U.S. returned to 4-5%.

Risk Management

With clients, we’ve seen a shift from talking about risk in financial terms to managing risk as an operational imperative. The basic struggle to get “rubber under the wood” and deliver needed logs to hungry mills during hot lumber markets took priority. Analytically and for annual budgeting, these can overwhelm the timber market fundamentals associated with forest supplies and wood demand.

Supply chain stresses have (1) highlighted the importance of locating in good local markets and (2) increased the appreciation for operational competence. From a risk management perspective, securing timberland assets with good proximity to diverse, well-capitalized wood-using markets is like setting up a natural, risk mitigating hedge, as timber assets in poor wood markets suffer disproportionately during recessions.

My view is that managing risk means being one of the best in your business. Someone always makes money, regardless the sector or geography or economic cycle. Investors that partner with strong operators that are good at what they do with solid relationships and a clear understanding of costs and value are well-positioned to prosper.