Economics of Timber Production on Private Land in Indiana

Economics or Finance?

Economics Timber owner is in general a price taker Competitive market position

Market for high quality timber of preferred species is global, unitary to slightly elastic demand

Market for low quality timber and non-preferred species is local, highly inelastic demand

National Hardwood Lumber Production

MMBF Peaked in 1999, 12.6 bil

2010, 6.3 bil

Weighted Average Price, Quality Stand

Black Walnut Sawlogs

Black Walnut Sawlogs, Real

Beech Sawlogs

Beech Sawlog Prices, RealTypical “flat-line” trend for non-prime species

Indiana Farm Real Estate

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$ pe

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1982 $’s

Nominal $’s

Trend line - 1.3%

Economics or Finance?

Finance Capital intensive

Land Growing stock

Long-term Highly appreciated

Position in Investment Markets Primarily a “life-style” investment

Highest and best use not timber production Cost of entry may exceed income potential

Some vertical integration Not attractive to institutional investors and

private equity capital Can’t capture economies of scale Can’t economically accumulate tracts into

investment grade bundles Limits resale market to other lifestyle

investors

Standard Measures of Financial Return

Net present value (NPV) Present value of discounted stream of revenues

and expenses V0 = Vn/(1+i)n

Internal rate of return Discount rate that makes NPV zero

NPV Calculation

Enter land and timber growing stock as up-front CAPITAL cost Standard assumption – capital costs based on fair

market value, Life style assumption – capital cost based on

actual cost, or zero if inherited Discount (interest) rate used

Nominal – rate on long-term corporate bonds Real – nominal reduced by average inflation rate

Real Interest Rate, 10-Yr. Treas. Sec., 3-Yr. Moving Average

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NPV Calculation

Time period Date of acquisition, to Expected date of death, or date of liquidation

Ending return on capital Bequest - none Standard - sale price (FMV) of land and growing

stock

Operating Costs

Allocate between personal and business use Property taxes Management fees Depreciation on equipment Other

Operating Revenues

Timber income Generally assume all-age management with

periodic harvests Estimate mean annual increment Project timber price

Other income Hunting lease payments Non-timber forest products Sale of development rights

Willingness to Pay for Land (WPL) Net present value of stream of revenues and

expenses Represents amount that can be paid for land

and growing stock Discount rate represents opportunity cost of tying

up capital in timber production instead of next best opportunity

Base Case, WPL, No Bequest Liquidate at dod, assumed to be 40 years 3% real discount rate Liquidate land at $1,500 per acre Liquidate all timber at $587/MBF real

Base Case, WPL, No Bequest Per acre costs

Annual - $20.00 Every 5 years - $250 Mean annual increment – 250 mbf Harvest revenue

Every 10 years, 2.5 MBF Price – quality stand price series, $643 nominal, $397

real Linear real price increase, $4.33 per year

Base Case, WPL, No Bequest – Liquidate

WPL40 = $1,755 per acre, real WPL40 = $2,845 per acre, nominal

Base Case, WPL, Bequest

WPL40 = $755 per acre, real WPL40 = $1,208 per acre, nominal

Barton Tree Farm (BTF)

Acreage – 292 Initial acquisition in 1980 Acquisition cost - $175,250 Total timber revenue - $324,800

BTF Initial Cost and Timber Revenues

1980 -$175,248.00

1984 $11,313.00

1985 $11,678.00

1988 $9,503.60

1990 $14,323.35

1995 $21,951.08

1997 $61,746.95

1998 $387.91

1999 $85,300.00

2001 $70,102.00

2005 $38,500

BTF Rate of Return, No Expenses, Bequest No operating or holding costs included

i = ($324,800/$175,250)1/25 -1 = 7.4% IRR = 2.50% nominal Internal Rate of Return

3.65% nominal 2.65% nominal after-tax

Inflation averaged 2.31% from 1980 to 2005

BTF, Rate of Return, Bequest Annual cost - $15.05 per acre per year,

$4,400 per year Before tax

IRR – 0.89% After tax – 28% ordinary, 15% capital gain

IRR – 0.5% after-tax

No Bequest, Liquidate

$15.05 per acre per year cost Sell land for $1,500 per acre

$438,000 Sell 2,354 MBF timber for $660/MBF

$1,553,640 ($5,320/acre) IRR

Before tax – 10.8% After tax – 10.2%