Other than oil and natural gas, guess what is the most widely owned commodity by the wealthy? As the headline gives away, it is timber.
Among households with over $2.5 million in investments excluding their primary residences, the average allocation to timber is almost 8%. Although timber does seem to be something of an all-or-nothing investment selection. A slight majority–about 62%–own no timberland rights at all. But of those that do, the average allocation to timber investments in their portfolio is almost 17%.
The appeal is that timberland is seen as a steady investment that can churn out cash flows during difficult economic conditions and are diversifiers from stocks, bonds, and whatever their core economic engine is.
In addition to the steadiness of returns, the wealthy also like the tangibility of a timberland investment. You can visit the land yourself and actually see the trees. You can climb them if you want. You can see them get cut down, and a check arrive the next month. It feels real because you can physically see the connection between your cash outlay and the work that goes into its conversion into a monthly income stream.
To get a large bank to arrange a timberland investment for you, you need to give them at least $5 million and agree to share 20% of the profits with the bank. If you have less than that to invest, you either need to manage the timberland yourself or find a boutique firm willing to manage on your behalf.
Do I consider this one of the wealthy’s finest economic innovations?
No, I do not.
For three reasons:
First, the cash isn’t as steady as you think. Between 2006 and 2009, the average timberland saw its monthly cash flows decrease by almost 70%. It was still a source of profit, but every $10,000 check shriveled into a $3,000 check.
Second, it takes almost three years for the typical timberland investment through a passive management scheme to be cash flow positive net of start-up investment charges.
And third, it has not been an impressively performing economic class over the past forty-five years. Since 1970, timberland has returned at a rate of 6.7%. And that is the do it yourself rate. If you have a property management company running the show, your returns are down to 5.3%. And then, there are taxes.
Huge caveat: Those 5.3% returns do not include any appreciation in the value of the land. That can be extreme or non-existence. The 25/75 figures for the returns on the land itself show a fluctuation between -2% and 7% annual appreciation of the land value. The general rule is that the typical appreciation of timberland value is a crapshoot.
My intuition is that if you are going to take ownership of private land, resources, or businesses, you should only do so when you are confident that you can get at least a 10% return. That is my minimum requirement in exchange for the significant time investment and possible hassle associated with active ownership.
Otherwise, I would much prefer to just add to an investment position in Exxon or Chevron. They didn’t have any cuts in their cash flows during previous oil gluts and recessions, and they give you returns in the 9-12% annual range in an entirely passive way. And you get a widely diversified stream of oil and natural gas rights that are professionally managed in an exceptional manner.
I’m reminded of Warren Buffett’s adage that the best next investment you can make is often an additional contribution to something that you already own. When diversification is your North Star rather than the greatest net-of-tax returns at the lowest possible risk, you are primed for “diworsifying” your portfolio.
If you are wealthy and intent on buying a privately owned asset, I would much prefer the acquisition of an apartment complex catered to a demographic that cares about their credit scores. If you invest $5 million into such a property, you ought to be able to convert that into a $20,000 monthly cash flow stream after payments for insurance, taxes, and the management company.
Sources:
Timberland Investments: A Primer
Timber! Why The Rich Are Buying Trees