Are Your Trees Making You Money?

Forest Finance Simplified, a book I originally wrote as a reference for myself when teaching Applied Forest Finance short courses, helps readers strengthen their use and understanding of tools used to manage forest resources as investments. Over time, I continued to revise the book and recently produced a brief video on “Why Read Forest Finance Simplified?”

Core Forest Finance Principles

Every forest owner interested in the financial performance of their asset should understand the core ideas related to the time value of money and opportunity costs. The time value of money reminds us that we prefer dollars today rather than dollars tomorrow (though I’m not sure that one requires much reminding). The application of this concept encourages us to invest in forest management activities that, for example, shorten forest rotations and accelerate the flow of cash from our trees.

Opportunity cost reminds us to always compare the placing of capital into forests versus our next best investment alternative. When gauging the value of a timberland investment, evaluate the forest based on its ability to generate income and returns moving forward. The only time we have complete control over our portfolio is today.

Common Errors

At times, investors decide to sell their timberland to lock in a profit or to reduce their forest management expenses to secure quick savings. While realizing profits or cost savings are generally enjoyable and pleasing to a cash balance, they sometimes sacrifice longer term goals or financial performance.

When someone talks about selling their timberlands, one question I often ask is, “what do you plan to do with the proceeds?” The tax implications and opportunity costs are too high for selling without a plan. A healthy timberland profit tagged with a big tax bill can become a pittance and hangover of regrets. Tax mitigation strategies and like-kind exchanges exist for reasons.

In addition, any across-the-board reductions in silviculture treatments deserve a careful review and consideration, as the impacts on forest productivity and returns will vary across the land and forest rotation. It’s one thing to reduce from four fertilizer treatments to three, and another to go from high quality seedlings to low. Each can save money in the short term, but they may also reduce future cash flows and returns. Do the math before cutting forest management.

Understanding Finance Improves Forest Investment Returns

Basic financial tools and frameworks help organize our thinking, especially when making changes. Years ago, a timberland-owning client optimized their forests for growing grade (sawtimber) volume rather than value (cash flow). They had focused on larger trees and volume, and one day decided to test the numbers on a financial basis. We helped them go through the exercise of comparing the value from the existing forest rotation versus alternative shorter rotations with prevailing timber prices. Based on the analysis, the owners immediately began reducing their forest rotations across the portfolio by six to 10 years. The changes increase cash flows, returns, and values.

With finance, you work with what the local markets and your soils give you to optimize the forest management plan.

When evaluating timberland holdings and investment decisions, revisit key questions, starting with your financial objectives. Ask, “Do my reasons (my investment thesis) for owning the asset still apply?” If the investment helpfully diversifies your portfolio and generates cash as needed relative to other investment opportunities, then your timberlands are doing what they are supposed to do.

For a range of objectives, finance represents a trade-off between today and tomorrow. Investing in something now – a factory, research, or timberland – means giving something today to gain in the future. The tools of finance help us assess whether each forest investment opportunity meets our specific objectives.