Timber REITs, Currently Out Of Favor, Could Provide Income And Long-Term Growth

Includes: CUT, PCH, PCL, RYN, WOOD, WY
by: Zvi Bar
Interest in timber land increased over the last few years, though interest did bottom out along with the market in 2008 and 2009. Demand for wood for use in construction has decreased dramatically, corresponding to the decrease in housing starts. Additionally, paper use, though still ubiquitous in our society, is expected to continue to decrease in the coming years due to digitization and other technological innovations.

Nonetheless, many individuals believe that now is a good time to allocate into timber. Due to the reduced demand for timber, prices are depressed. As a result, most timber growers are allowing their trees to grow. They will be left with more trees and an older stock, where those older trees may produce superior, high priced wood product at a later date. Moreover, timber product prices have a history of increasing at a rate that outpaces inflation.

Currently, some of the largest owners of timber acreage within the United States are housed within real estate investment trusts (REITs). REITs must distribute at least 90% of their taxable income in order to eliminate the need to pay income tax at the corporate level. Under the current tax laws, timber REIT dividends are taxed as capital gains, and not at the corporate dividend or ordinary income tax rates.

Because REITs must give away so much income, they cannot grow through retaining and re-deploying earnings. This is not so much of a problem for timber REITs in this environment, as the lack of present demand for timber products should allow these companies to structure themselves in a manner that minimizes expenditures and overhead. Essentially, these companies should shed non-core businesses and simply allowing the timber to grow until demand and prices reach desirable levels. Once that happens, any profits should then be distributed.

Below are four timber REITs that are publicly traded in the United States, listed in alphabetical order. I have provided their present yields, as well as their 1-month, 3-month, 6-month and 2011-to-date share performances. Again, please note that REIT dividends are taxed as ordinary income, and not at the lower corporate dividend rate.

Plum Creek (NYSE:PCL)
  • Yield: 4.69%
  • 1-month: -1.95%
  • 3-month: -14.50%
  • 2011-to-date: -10.33%
Potlatch (NASDAQ:PCH)
  • Yield: 6.4%
  • 1-month: 2.52%
  • 3-month: -10.92%
  • 2011-to-date: -1.11%
Rayonier (NYSE:RYN)
  • Yield: 4.26%
  • 1-month: -6.69%
  • 3-month: -16.91%
  • 2011-to-date: 1.36%
Weyerhaeuser (NYSE:WY)
  • Yield: 3.8%
  • 1-month: -7.66%
  • 3-month: -28.67%
  • 2011-to-date: -16.53%
These timber REITs have all performed poorly through the last quarter. It is possible that some larger holders needed to liquidate their timber investments in order to raise cash. These investments are often favored by focused hedge funds, many of which saw significant recent increases in redemptions.

Beyond these REITs, some exchange traded funds (ETFs) also exist. The iShares S&P Global Timber & Forestry Index (NASDAQ:WOOD) tracks the performance of the S&P Global Timber and Forestry Index, and the 4 above-listed timber REITs are its top 4 holdings, comprising just under 30% of WOOD’s total portfolio. See the chart for WOOD, below. Click to enlarge:

Additionally, the Guggenheim Timber ETF (NYSEARCA:CUT) corresponds to the Clear Global Timber index, where these 4 REITs comprise just under 19% of CUT’s total portfolio. See the chart for CUT, below. Click to enlarge:

Both of these funds also hold significant positions in companies that produce and sell products made from trees, such as paper and packaging, and both appear to have performed similarly during the recent market sell-off, even though their portfolios do exhibit several differences.

Disclosure: I am long WY.
Disclaimer: This article is intended to be informative and should not be construed as personalized advice, as it does not take into account your specific situation or objectives.