One reliable way to underperform as an investor is to buy assets or stocks at the top of the market. What gets priced up ultimately falls, adjusts or reverts to the mean, thanks to arbitrage and horse trading. Alternately, outperformance thrives on the upside of undervalued securities, such as cash-generating businesses that own hard assets. Prime candidates from 2018 include publicly-traded, timberland-owning real estate investment trusts (TREITs). What is the current situation with timber REITs? How could investors evaluate the opportunities in the timber REIT sector for 2019?
Timber REITs Tumble in 2018
Public timber REITs, along with the balance of the stock market, delivered truckloads of heartburn to investors, especially in the second half of 2018. For the year, the public timber REIT sector lagged far behind the S&P 500, which had its worst year in a decade. (In 2008, the S&P 500 returned -38.5% and the FTR Index returned -25.4%).
Even at the individual firm level, each stock underperformed the S&P 500. For comparison, timberland-owning Pope Resources, a master limited partnership (MLP), kept up with the broader market and outperformed timber REITs. (We note that the figures only reflect share (unit) price returns and do not include the distributions delivered by all five firms to their investors.)
Evaluating Timber REIT Investments
We note that the timber REIT sector gained nearly 16% during the first month of January, reflecting the start of a sharp recover. For investors considering timber REIT stocks, it helps to have an approach. When evaluating the risk and potential returns of public timber REITs, we start with an ROV framework, applied in this order:
- Regulations: Is the firm in danger of losing its REIT status with the IRS? Will changes in tax laws, if any, affect the attractiveness of owning REITs?
- Obligations: Is the firm generating sufficient cash for key obligations? (Think “debt and dividends.”)
- Valuations: How are assets valued and performing relative to its current share price and over time?
The framework acts as a systematic screen that first addresses key regulatory and credit risks, followed by relative return potential and attractiveness. Investors value timber REITs when deciding whether or not to accumulate or dispose of shares. Does the firm’s share price imply that it’s under or over-valued relative to the value of its assets and future prospects? When valuing timberlands and timberland-owning REITs, estimating value is a function of estimating and, ultimately, discounting cash flows. If a timber REIT exhibits strengthened cash flows over time, this leads to expectations of higher distributions, high values and higher share prices.
The biggest risk for a potential investor is paying too much to get in. The biggest risk for a current investor is sub-optimizing the assets under management. As such, key metrics for evaluating timber REITs include net asset value (NAV), relative performance against private timberland investments and cash flows, both current and expected.
This content may not be used or reproduced in any manner whatsoever, in part or in whole, without written permission of LANDTHINK. Use of this content without permission is a violation of federal copyright law. The articles, posts, comments, opinions and information provided by LANDTHINK are for informational and research purposes only and DOES NOT substitute or coincide with the advice of an attorney, accountant, real estate broker or any other licensed real estate professional. LANDTHINK strongly advises visitors and readers to seek their own professional guidance and advice related to buying, investing in or selling real estate.
Dr. Mendell,
Appreciate your insight into the Timber REIT space and what may be an opportunity for future growth in this area.
I went to your site at Forisk and looked at the course schedule for this year and noticed a February 19 course in forest finance.
This is a area that we have had success in with our farm clients who want to defer their current income tax on this year’s production sales far into the future, sometimes up to 30 years.
You are probably aware of this strategy that has been used by Kimberly Clark, Glatfelter, Rayonier, Greif, Office Max, International Paper, MeadWestvaco, The St. Joe Company and others.
Farmers First Trust Company has democratized the complex transaction associated with the tax deferral strategy utilized by these timber companies, so that the small to midsize timber companies can take advantage of the tax planning just like the large fortune 500 international timber organizations have been doing for more than 30 years.
I would like to show your group how we may assist in creating more current cash for timber operators without any increase in overhead.
Sincerely,
Richard Schmitz