Institutional Timberland Investments: Asset Pricing and the Discount Rate

Abstract

Timberland has become an increasingly popular component of the portfolios of large investors, both institutional and also those of wealthy individuals and trusts. This land is generally managed by timberland investment management organizations (TIMOs). Since the early 1980s, the amount of timberland held by investors and managed by TIMOs has increased from practically nothing in the early 1980s, to over $25 billion by 2005. In spite of the attention paid to timberland investments in recent years, questions still remain in regards to the price determinants of timberland, as well as the asset’s risk and return characteristics. This study uses a database of over 600 actual timberland transactions which occurred between the years 1988 – 2010, to address questions relating to timberland investments. A hedonic model of timberland price is developed to analyze the determinants of timberland price. In addition, using tract level data in combination with industry practices and market prices, an NPV model is used to forecast cash flows and solve for the discount rate, given the sale price associated with each transaction. Lastly, least squares regression is used to analyze the discount rates in an effort to qualify and quantify both market and diversifiable risk inherent in a timberland investment. Findings support the hypothesis that both the standing timber, as well as a tract’s timber producing capability, has a large impact on timberland price. In addition, characteristics regarding location, HBU potential, price expectations, and macro variables such as exchange rates also play a significant role in determining the timberland price. Historical discount rates are found to average 6.59 percent for low intensity management regimes, 8.98 percent for medium intensity management regimes, and 12.5 percent for high intensity regimes over the period 1997 – 2010. There was also a significant downward trend in discount rates from 2001 – 2008. Model results to describe the discount rate are questionable. It is found that both systematic and non-systematic risk is priced into timberland. However, some variables are found to have the opposite effect than is expected.