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When rental rates go down, most REITs lose revenue. For timber REITs, however, it is simply deferred. During times in which demand for logs and other timber products is low, timber REITs can refrain from cutting the trees which continue to grow and gain value. Upon demand (and higher prices) returning, the now larger trees can be cut, sold, and replanted. So, while a timber company's on-paper earnings may decline significantly during recessions, the actual rate of value production remains fairly constant, just deferred. There are a couple exceptions to this which are explained below:

Maturity dependent growth rates, weather, and disease

· Inclement weather can stifle growth or even outright kill trees. Any area sustaining significant damage may have to be immediately harvested and thus sold even if prices are low. Unfavorable weather conditions can last for years, but timber companies have two excellent ways of mitigating this damage: Geographic diversification, and a broad mix of species across sites.

· Diseases, or recently parasites, are capable of devastating entire regions of woodlands. Canada recently suffered a Pine Beetle epidemic which forced massive amounts of immediate harvest. Like issues with weather, problems with diseases and parasites can be prevented. Plum Creek Timber (PCL) has also encountered pine beetles, but through clear-cutting any area in which these are found, PCL has been able to prevent spreading.

· Over the years, the rate at which trees grow as they mature has become very well documented. This rate provides excellent information as to the marginal returns of allowing a tree to continue growing. Essentially, there is a mathematically optimal age at which to harvest each tree, and when the harvest time is deferred until market prices come up, it comes at the cost of growth rate. That being said, the window in which growth rate is only slightly diminished is many years long, so deferral can be quite an effective means of preserving value generation. For example, for the year of 2012 Potlatch Corp. (PCH) issued guidance to electively reduce its harvesting to 800,000 tons below its potential.

When housing and other uses of timber are booming, this harvesting deferral has the opposite effect. Since many companies choose to maximize harvesting when log prices are high, it creates an influx of supply which in turn keeps the prices a bit lower. Therefore, the deferral of harvesting may not increase the overall profitability of the industry, but it makes the rate of value generation for timber REITs much smoother across all economic cycles.

As further evidence of the stability of these companies we can turn to historical data. As we know, housing start-ups are one of the primary indicators of demand for lumber products. With the crash of the housing bubble came the worst number of housing starts in over 30 years. The sheer magnitude of this drop in demand can be seen on this graph from Potlatch's presentation.

(click to enlarge)

Company (ticker)

Recent Market Price $

Market Capitalization $

Plum Creek Timber

$42.60

$6.88B

Potlatch Corp

$38.12

$1.54B

Rayonier Inc. (RYN)

$48.52

$5.94B

Weyerhaeuser CO. (WY)

$26.64

$14.33B

Despite this historically significant crash, all four timber REITS paid dividends through the entirety of the downturn. Deferral of harvesting combined with the geographic and product diversification of these REITs makes them incredibly stable. The role of these stocks as a value play or their potential for total returns is a separate issue that we did not cover in this article, but the timber REITs certainly could be used to hedge a portfolio against recession.

Disclosure: This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the author.

Source: Timber REITs Prove To Be A Very Safe Bet