As a recent retiree I am a faithful follower of Seeking Alpha and an avowed dividends growth investor. Of particular interest to me are articles on Timber REITs by authors such as Avi Morris, Kevin McElroy, Zvi Bar, Bear Fight, George Fisher and others. From the comments on these articles, it seems to me there is misunderstanding, or lack of understanding, by many investors on what Timber REITs are and whether they are good investments or not. I believe that investors should understand the businesses of the companies they invest in, so I offer here a primer and high level history of the Timber REIT Industry.
Before the mid 1980s, large acreages of commercial timberland were owned by vertically integrated timber companies like Weyerhaeuser (NYSE:WY), Georgia Pacific, International Paper (NYSE:IP), and many others. Vertically integrated timber companies owned the timberland, the pulp and paper mills, sawmills, plywood mills, etc., as well as the sales organizations to sell the finished forest products to end users. A common setup in the Southeast at that time was for a company to own a pulp and paper mill, three or so sawmills or plywood mills, and about a 500,000 acres of land to supply raw materials to the mills. This setup usually supplied about 35% of the wood needs of the mills with the rest coming from private lands. In the West things were different as the US Forest Service supplied large quantities of logs to mills, and mills were usually located in close proximity to Forest Service lands. Western mills also owned large acreages of timberland themselves as in the Southeast. The Southeast was dominated by pulp and paper mills who also owned sawmills and plywood mills to more fully utilize all of the logs produced on their lands. Western industry was more focused on sawmills with pulp mills being there to use the residue from sawlog production.
Around the mid 1980s two things happened that changed all of this. First, some people in Atlanta and Boston came to the conclusion that owning timberland was an ideal investment for pension fund investors. This was because timberland was a long term investment that threw off a somewhat steady cash flow. In addition, this cash flow could quite easily be turned on and off or up and down as pension fund needs dictated. If you did not harvest the trees, they kept on growing and increasing in value. A new type organization, the Timber Investment Management Organization (TIMO) sprang into being to facilitate these investments.
The second thing that happened was that some investors noted that the share price of most vertically integrated forest product companies usually did not reflect the value of the timberlands. Companies such as Continental Can and Crown Zellerbach were early victims of hostile takeovers. Those taking over the companies sold off the mills, usually for the price paid for the company, and were left with a million or so acres of timberland for free. The timberland could then be sold to the newly arrived pension fund investors. To combat this, many companies adapted poison pills or spun their timberlands off into separate companies. This process accelerated throughout the late 1980s and early 1990s.
In the early 1990s private investors started taking notice of the investment returns that pension funds were making on their timberland investments. Some of these returns were north of 20%. Some of this was due to the early pension fund investors having bought low when timberland was plentiful and buyers were few. In any case, private money started competing with pension fund money for timberland as an investment and the process further accelerated. Another major event that happened in the 1990s was that environmental pressures in the form of the Spotted Owl in the West and the Red Cockated Woodpecker in the Southeast removed most or all of the publicly owned timberlands from timber production. This constriction in supply made the remaining private timberlands and the logs produced from them more valuable. Most of these timberland investments, managed by TIMOs, were held in private funds with investment terms of ten to fifteen years.
By the mid to late 1990s people noted that the REIT structure was ideally suited for timberland ownership. Pension funds did not pay taxes but private investors did. The REIT structure allowed the cash generated by the timberlands to pass through to individual investors and escape corporate taxes. Another thing that happened in the 1990s was a large number of mergers and acquisitions in the forest products industry. The big three were Weyerhaeuser, Georgia Pacific, and International Paper. After most mergers some timberland was put on the market and gladly scooped up by TIMOs.
Plum Creek (NYSE:PCL) was the first Timber REIT. It started as an MLP with lands previously owned by Burlington Northern. They further acquired lands owned by Champion International, Riverwood International, and Sappi. In 1999 they converted to a REIT and then merged with The Timber Company which was a spinoff of Georgia Pacific Corporations' timberlands. Rayonier (NYSE:RYN) and Potlatch (NASDAQ:PCH) soon followed and were reorganized from their previous C corporation structures to REITs to take advantage of the tax savings. By the late 2000s, Weyerhaeuser was the last man standing as a vertically integrated timber company. A little over a year ago, Weyerhaeuser finally succumbed and converted to a REIT structure. So now we have the Big Four Timber REITs, Plum Creek, Rayonier, Potlatch, and Weyerhaeuser. To this group we could add Pope Resources (NASDAQ:POPE) which is an MLP. Pope is very small by the others standards but is the only pure timberland play among them.
The table below outlines the number of acres, in the US, owned by Timber REITs and one MLP by Region. These numbers came from the company web-sites.
Timberland REIT Acres by Region (US)
In general timberland in the Pacific Northwest is the most valuable going for between $2,000 and $3,000 per acre on the average. Southeastern timberland generally goes for $1,200 to $1,800 per acre. Timberland in the other three regions generally sells for between $300 and $700 per acre. Mind you these are rough estimates. Because of the housing slump, demand for timber has been down for several years. One exception is the Pacific Northwest where strong demand for logs and lumber from China has led to a strong recovery for timberland owners in this area since 2010. As you can see from the chart above, not all Timber REITs have the same exposure to this region. Potlatch has none, Rayonier has only a 20% exposure, Weyerhaeuser a 33% exposure, Plum Creek a 7% exposure, and Pope a 100% exposure to Asian markets.
Timber REITs make money in three ways, log or stumpage sales, real estate, and manufacturing. Most REITs are not pure timber plays. Manufacturing is not a normal REIT business. REITs, however, are allowed to own taxable corporations as wholly owned subsidiaries. All four Timber REITs own some manufacturing mills in taxable subsidiaries. The table below shows where revenues come from based on the latest information I was able to find in company 10Ks for 2010 or 2011. These percentages most likely change from year to year but this still illustrates that all timber REITs are not created equal.
Percent of Revenues by Source
Pulp & Paper
Timber and Real Estates would constitute normal Timber REIT businesses. From the chart above Plum Creek generated 25% of its revenues outside normal REIT businesses, Rayonier 81%, Potlatch 50%, and Weyerhaeuser 71%. The point I hoped to make with the two charts above is that Timber REITs differ in both geographic diversity as well as business models.
One of early draws to Timber REITs as investments was high dividends. Dividends ran in the 6% range not that long ago. Current yields have fallen as share prices have escalated and cash flows from timber and real estate has suffered due to the collapse in the housing industry. The table below shows yields as of 3/13/2012. Of the five companies listed, only Potlatch has cut dividends recently. When the housing market recovers all of these REITs should show considerably improved cash flows.
So, that concludes my story on Timber REITs. This article was meant to be informational so as to inform investors just what they are investing in when they buy shares in Timber REITs.