In response to the climate crisis, many environmental activists have promoted the idea of planting more trees and investing in woodland areas. However, before jumping on the visionary bandwagon it is important to understand the economics of investing in trees and the potential benefits that it provides.
Internal Rates of Return
The valuation of timberland and the returns that can be gleaned from its investment have been examined extensively over the last two centuries; ever since the formulation of the Faustmann Formula in 1849, in which forest land expectation values could be more easily quantified1. However, in the modern investment climate the most important factors to understand when considering an investment, is the internal rates of return (IRR), which in this case demonstrates the potential profitability of owning an area of woodland.
To reach the estimate of the profitability of an area of timberland several criteria are examined to gauge the likely future value and risk. These factors include:
- Tree growth rates
- Rotation ages
- Final harvest volumes
- Prices and the cost of managing or establishing a forest stand2
Overall, the IRR of owning a woodland across the globe compares well against other assets of a similar nature. In South America, China and Vietnam a potential investor can expect a rate a return of around 12%, whilst in other Southern hemisphere countries, such as Australia and New Zealand, investment generates approximately 8%. In Europe, IRR of timberland is generally lower, producing only 4-8% returns, but it is generally a far safer investment due to reliable infrastructure and the low chance of malpractice in management 3.
Northern hemisphere temperate species of timberland suffer from slower growth rates in comparison to the exotic plant species found in the tropics. Furthermore, investment confidence in North American and Europe was undoubtedly damaged by the economic recession of 2007-09. This resulted in plummeting global demand for sawntimber products, the majority of which originated from plantations in the North1. This supports recent macroeconomic evidence that investing in the inflating Asian and African markets of timberland and other commodity assets is likely to generate the greatest future returns.
It must be considered that these figures are all taken prior to the COVID-19 epidemic, which may have altered the economic profitability of investing in timberland. However, timber stocks are not as volatile as many other commodity investments and therefore may not have been overly degraded by the economic downturn. Furthermore, the profitability of investing in timberland based of these figures cannot be considered entirely accurate, as many of the studies which produced these figures made a variety of assumptions about economic factors and variables, such as inflation effects and timber price variations.
Net Present Value and Land Expectation Value
Two other important figures that are likely to impact on an investors decision to purchase an area of timberland are the net present value (NPV) and the land expectation value (LEV). As defined by B. Mendell (1990) , NPV refers to: “the present value of future revenues minus the present value of future costs”. Clearly, this value will play an important factor in investment determination, as it displays the amount of wealth that can be generated from the investment relative to the time value of the money involved in the purchase.
More simply, NPV amalgamates the future values that can be gained by the timberland invested and ‘discounts’ them to reflect the decreasing value over time of the investment. This future value will consider external factors to the purchase, such as interest and inflation. As exemplified by K. Holland (2020): “You may agree to rent on a woodland or property at £10,000 per year for 10 years. But the £10,000 in year 10 is worth less than the £10,000 in year 1.”
This NPV value is a great determinant on whether an area of woodland is a worthwhile investment. However, if an investment has an NPV of less than zero it shouldn’t be disregarded as unprofitable. Investment firms all have slightly differing discount rates due to changing assumptions on future economic conditions. Any investment can produce an NPV of less than zero if the calculated discount rate is too high. Therefore it is always worth revisiting this value before disregarding an investment as unprofitable due to a its NPV.
In forestry, LEV refers to the estimated market price of bare land if it were used for constant timber production. This ‘present value’ which makes up an LEV, is formulated using a discounted cash flow (DCF) calculation with several assumptions factored in, such as a perpetuity of forestry on the land and regeneration cost4.
When considering investment in a timberland area, it is vital that these valuations and estimations are scrutinised at length to ensure a profitable investment. It is also worth noting that to maximise potential profits gained from buying an area of timberland, a prospective investor should also aim to procure woodland containing a significant amount of young mature, or immature trees, to benefit from the initial harvest.
Once purchased, an area of woodland can only remain profitable if managed in an appropriate and sustainable manner. This includes the balancing of societal, environmental and economic objectives to ensure the proper use of the forest resource. More information on sustainability and forest management can be found here.
- Fredrick, C., (2020). Global timber investments, 2005 to 2017. Elsevier. Forest Policy and Economics. Vol 112
- Chudy, R., Cubbage, F., (2020). Professional Insight: An Interview with Professor Frederick Cubbage of North Caroline State University. Forest Monitor blog
- Bullard, S.H., Straka, T.J., (1996). The land expectation value calculated in timberland valuation. Faculty Publiucations. Austin State University