Investors are knocking on wood

Affordability helps heighten attraction to timberland as a hedge against inflation

Institutional investors are investing in timberland, trying to fill new inflation-hedging allocations.

A number of them — including the Florida State Board of Administration and Kansas Public Employees Retirement System — have launched searches for timberland managers.

Globally, investors also are showing interest in investing in timber, both in emerging markets and the U.S. Recently, ATP, Hilleroed, Denmark, committed 3 billion Danish kroner ($582 million) to a portfolio of direct investments in timberland.

There's a growing understanding among investors of the importance of long-term real returns, noted Howard Kaplan, who heads the natural resources division of Cleveland-based consulting firm ORG Real Property.

“I think some investors like renewable resources because they have a long-term perspective and, long term, they are a good inflation hedge,” Mr. Kaplan said.

Investors are trying to get into the asset class now because the timberland market, which had become fairly pricey between 2007 and 2009, is becoming more affordable, said Dick Molpus, president of Molpus Woodlands Group LLC, a timber investment management firm in Jackson, Miss. The firm was a net seller over the past several years, but entered into two large deals in the fourth quarter when timberland prices started falling.

In the U.S., timber performance is tied to, and somewhat lags, housing, Mr. Kaplan explained. “When housing got overheated, it bled through to the timber market,” he said.

Since prices started falling last quarter, Mr. Molpus said, his firm has been deluged by calls from institutional investors attracted by the steady positive returns and inflation-hedging properties of timberland.

“Roughly 60% of the return from timberland investments is from the biological growth, which protects the corpus of the investment,“ Mr. Molpus said.

Indeed, for timberland managers one of the most difficult investment decisions is to know when to cut the trees, said Steve Diebenow, principal at Jacksonville, Fla.-based Rock Creek Capital. In good markets, you cut trees; in bad markets, you don't, he said.

“The hard part of investing in timber is, when prices start to drop, you have to have the discipline not to cut your trees,” he said. “As long as it's sunny and there is water, your product continues to grow.”

The $114.7 billion Florida State Board of Administration has been searching for a timberland manager for several months, said Dennis D. MacKee, FSBA communications director in Tallahassee. The board's real estate consultant, Townsend Group, is conducting the invitation-only search. Timberland is part of what the board calls a multisector allocation that also includes infrastructure. For the fiscal year ending June 30, the board has allocated up to $500 million to the allocation.

The $11.6 billion Topeka-based Kansas Public Employees Retirement System's board will be considering its first timber investment as part of its 14% allocation to real return at its Jan. 15 board meeting, said Robert “Vince” Smith, chief investment officer. Mr. Smith declined to provide details of the proposed investment in advance of the meeting.

The board has been researching the addition of timber and other investments since 2008, when it adopted the real return allocation. The timing is right to invest at better prices and in advance of a possible inflationary environment, he said.

“During a weak economy and low inflation is a good time to buy these types of assets,” Mr. Smith said.

Smaller pension systems also are investing in the strategy. For example, the Alexandria (Va.) Firefighters & Police Officers Pension Plan and Davie (Fla.) Police Pension Plan are searching for timber investment managers. Alexandria is looking to commit about $5 million to $10 million; Davie is targeting $3 million.

Institutional investors are also investing in timberland in their equity and real estate investment trust portfolios. In the past few years, a few private timber companies have converted to REITs, making the sector a small but significant portion of the NAREIT index. Weyerhaeuser Co. is expected to become a REIT in the first quarter.

With Weyerhaeuser, the four timber REITs will make up a significant slice of the total REIT market, and between 5% and 8% of the NAREIT index, said Michael Grupe, executive vice president for research and investor outreach at the National Association of Real Estate Investment Trusts, Washington. NAREIT executives are discussing whether to break out timber REITs into a separate subcategory, he said.

Returns of the timber REITs now in the index have tracked the NAREIT Equity index. The three — Plum Creek, Rayonier and Potlatch — delivered a one-year total return of 26.46%, and a three-year annualized return of 5.87% for periods ended Dec. 31, according to data provided by NAREIT. By comparison, the NAREIT Equity index returned 27.99% for the year and -12.41% for the three years.

Timberland managers say it's a good time to invest because prices, which had been sky high, just began to fall last quarter. For example, timberland values in the Southeast United States are 25% below 2007 prices, said Craig King, president and CEO of J.P. King Real Estate Auction Co., a Gadsden, Ala.-based national real estate auction marketing firm.

Many of the current sellers are reinvesting in cheaper properties, Mr. King said. Sellers run the gamut from pension funds and college endowments to timberland investment management firms and REITs, Mr. Molpus said. Mr. Molpus said his firm also expects to be a net buyer this year and next.

Rock Creek Capital also is buying timberland — for the first time since 2004 — and expects to be a net buyer of timberland for the foreseeable future, said Mr. Diebenow.

“From our perspective, we stopped underwriting pure timber deals in 2004; primarily because we thought the prices were too high. Only in the last 90 days have we started looking at pure timberland deals again,” he said.

“Overall, the timberland business became very overheated in 2007 and 2008 and most of 2009,” Mr. Molpus said. “We sold many of our investors out during that period. Now we are seeing timberland prices drop 10% to 20% and if it is bought carefully, it can lead to a respectable 8% to 10% return.”