Literature Review
This chapter delves in generating a basic understanding of the timber investments. It begins by exploring the growth characteristics of the timber investment, followed by an examination of the primary sources of returns. The next sections are timber prices and the impending risk factors that are likely to thwart timber investments.
Growth Characteristics of Timberland
Timber investors perceive timber investment as one of the most sustainable and valid long-term growth strategies compared to traditional stocks and bonds. While market fluctuations primarily influence the demand and supply of stocks and bonds, the long-term market performance of timber is also influenced by trees’ biological growth characteristics, rather known as ingrowth characteristics. Unlike any other product or investment, timber investments are unique given their ability to exponentially increase value over time. As trees grow, their volume increases yielding more wood and value. In simple terms, older and larger trees generally have more value than young and smaller ones.
Additionally, it is important to note that unlike other products, trees never exhibit direct proportionality. Normally, a product whose value is twice the value another similar product would cost twice the price of the other. For timber, the fact that one is twice the volume of another does not necessarily mean that their prices would vary by the same proportion, even if they are of the same kind. Usually, the value of trees grows exponentially and not linearly. Further, the quality of timber improves as a tree matures, generating higher investment values. Finally, unlike other natural products which are subject to perishability and value degradation, making them less favourable over time, trees actually increase value. As such, timber investors can wait and sell their products when they are mature enough and when market prices are attractive to them.
Given the biological growth characteristics of trees, timber investments can generate immense returns even if factors of production, majorly land, and market prices remain the same. Another biological advantage of investing in timberland is that, if timber in the same land is harvested at the same time, they will regrow at the same rate while multiplying at the same time, assuming other factors remain constant. As a result, a timber investor has an opportunity to generate snowballing revenues into the unforeseeable future, without necessarily committing more investment resources. Biological characteristics, therefore, provide a natural hedge that protects investors against economic fluctuations such as changes in costs of factors of production and timer prices.
Timber Prices
The prices of timber and timber products contribute a considerable chunk of the timberland investment returns. Timber prices are highly volatile and keep fluctuating. These price fluctuations contribute to about 35% of timberland return on investments. Hence, timber prices are impacted by both microeconomic and macroeconomic factors. Like any other investment portfolio, the fluctuations in timber prices pose the highest investment risk to timberland investors. Timber prices have both short-term and long-term impacts on the return capacity of timberland investments. In the short-term, the volatility in timber prices may have devastating effects on the investment returns of timberland investment. However, this price volatility has minimal impact on the long-term return capacity of timberland investments. This is because other factors, such as the biological growth of timber, influence timber production positively throughout the venture.
Furthermore, biological growth is not influenced by the various microeconomic and macroeconomic forces of the business environment. In this manner, natural growth characteristics of timber cushion timberland investors from negative long-term impacts of price fluctuation and uncertainty. Consequently, timber prices have a favourable long-term investment return potential despite prevailing economic volatility. The long-term ability of timber prices to cushion investors from inflation and other economic lows is depicted in the figure below:
The microeconomic factors affecting timber prices include the cost of timber harvesting and transportation to the markets, the prevailing political environment, the relative prices of competing products, and the capacity of a given region to process timber grown there. The cost incurred during timber harvesting has direct impacts on the market prices of wood. Timber harvesting and transportation entails logging and the subsequent movement of harvested timber to the yards for distribution to the market. The general cost of fuel impacts the cost of harvesting and shipping. Higher fuel costs lead to higher costs of timber harvesting and transportation, which in return lead to increased timber prices. Timber harvesting and transportation are also influenced by weather and climatic conditions. Dry seasons facilitate easier harvesting and transportation; thus, costs of harvesting and transportation are lower during dry seasons as compared to wet seasons. This is because the timberlands are more accessible to personnel and machinery used in harvesting and transportation. The available transport infrastructures also determine the transportation costs of timber. Proper transport infrastructure, especially road and rail networks, facilitate efficient transportation of timber hence guarantee a market-friendly price on timber and timber products.
The political environment majorly impacts investments through the legislative modulation of the economic climate. Such legal interventions may take the form of direct and indirect incentives or disincentives to potential timberland investors, government involvement in timberland investment through direct plantings, and provision of frameworks to guide forest plantation and timberland investment. Framework policies such as the provision of robust land tenure systems and setting up of strong forestry institutions help in the eradication of phenomena like overproduction and underpricing. These framework policies consequently lead to favourable timber prices, which make timberland investment viable.
The cost and availability of competing products also impact the prices of timber and timber products. Timber is majorly used in the building and construction industry, as well as furniture-making, among other related and unrelated uses. The products that can be substituted for timber in these tasks include concrete, metal, plastics, and fibreglass. Therefore, the relative abundance and cost of these products directly impact timber prices. If the alternative products are plentiful in the market, their prices consecutively drop considerably. When these prices fall relatively below the market cost of timber, many consumers may substitute timber with alternative products, leading to a decline in timber prices due to lowered demand. This price fall leads to short-term negative impacts on the return on timberland investment. Value addition can be used to boost timber prices by converting the timber to various products such as paper and cardboard. This requires the presence of timber processing factories in a given region. Consequently, areas with a higher timber processing capacity can diversify their timber market by making a wider variety of timber products. The increased variety and value addition boost the ability of the timber to generate higher prices.
On the other hand, the macroeconomic factors influencing timber prices include typical economic, environmental determinants such as interest rates and exchange rates, GDP, population growth, and the rates of unemployment. The status of new building and construction activity also influences timber prices through the forces of demand and supply. Therefore, favourable macroeconomic and microeconomic factors lead to short-term positive leaps in timber prices.
Risk Factors
Risk is an indispensable component of any investment venture. Contrary to the common perception of risk as to the potential for adverse outcomes and losses, investment risks are the potential variations in expected investment outcomes. In this context, risks may confer positive or negative consequences. Timber investment is also marred by a variety of risks that affect the performance and return potential if timberland investments. The risks faced by timberland investors are broadly grouped into four classes, namely, regulatory risks, financial risks, physical risks, and operational risks. Regulatory risks refer to all the issues that compound policy decisions affecting timber investment. Such factors include social pressure, land use regulations, and certification requirements. The most notable regulatory risks are the policy decisions by federal and state governments to curb certain forest management practices. For example, government policies to protect particularly endangered species of trees may curtail the direct sale of these trees hence limiting returns from direct sales of such trees. On the flip side, such a policy may spark higher returns for investors from government rewards and direct or indirect earning from conservancy work such as tourism levy.
Financial risks are the various factors that affect the number of monetary inputs and outputs associated with timber investments. Price fluctuations affect the entire chain of production in timber investments, beginning from initial timberland acquisition and preparation to harvesting, transportation and processing. The prices of various inputs determine the cost of production for timber and timber products. These costs are directly impacted by the forces of demand and supply, as well as the macroeconomic and microeconomic factors of timber price, as discussed in the preceding section. The seasonal fluctuations in the costs of timber production produce accompanying volatility in the cash flows realized from the sale of timber and associated products.
Physical risks of timber investment encompass a variety of natural and environmental factors that influence the quality and quantity of timber and timber products. These factors include pests and diseases, fires, and climatic hazards such as floods and droughts. Regardless of the severity of natural risks and calamities, their gross impact on the output value of timber investments in very minimal. This is because mature timber can be easily and naturally be salvaged from the ravages of physical calamities while preserving their market value. Studies of the impacts of natural risks on timber investment show that mature trees exposed to damage by natural disasters like hurricanes and forest fires are usually salvaged with over three-quarters of their timber value. However, these physical risks can be very destructive to young trees, leading to huge losses on timberland investments.
The operational risks include factors that influence the feasibility of the management of the timberlands. Such factors include weather and transport infrastructure that affect the ease of access to timberlands during harvesting and transportation of timber and timber products. The operability of timberland is mainly influenced by weather and the transport infrastructure. Inaccessibility of timberlands leads to increased costs of harvesting and transportation, which may, in return, lower the return potential of timber investments. A fifth risk factor of timber investment entails the dynamics of the timber and timber products market. The timber market is an imperfect and inefficient market characterized by fewer buyers compared to other investment portfolios. Unfair pricing strategies also dog the timber market due to the absence of standard pricing policy in the market. Such market inefficiencies diminish the returns for many timber investors. On the other hand, experienced and highly skilled timberland investors and managers can carve out a niche for themselves and enhance profitability in the timber market.