« Financial Planning

Investing in Forestry

The subjects introduced here are highly complex and should be examined more thoroughly before important financial decisions are made. Consult the references used for this section for more detailed information.

• Introduction

  If you own forest land, you may be wondering if you can make money growing trees.  There are many factors to consider in determining the answer to this important question.  Even if income from timber is not your primary objective, management to improve wildlife, recreation, or other values can result in a profitable timber investment.

  Consider this projection:

  Demand for forest products is expected to double by the year 2030 because of a growing population and an increasing per capita use of wood and paper products. With decreasing harvests in National Forests, the nation is depending on the productive woodlands of the South to meet this demand.  The 13 Southern States now produce about 45% of the nation's harvest. These states are expected to supply about 55% of the increased harvest by 2030. This is more wood than the entire nation harvests now, and translates into a significant opportunity for landowners who are managing their timberland now.

  Currently, timber growth exceeds harvest, but some problems exist:

  • There is a steady decline in forest land because many landowners harvest timber without proper planning for reforestation.
  • Growing cities, agricultural expansion, and other uses steadily convert forest land to other uses.

  These problems make it necessary to grow more wood on fewer acres, which requires more intensive management. 

  Investing in forestry is complex business, but when all factors are considered, forest management can be a profitable investment for many landowners.  Your decisions must be based on your land, your abilty to invest, and your goals.  A financial analysis is an important part of this decision-making process.

  A financial analysis is used to: 

  • compare land uses (timber, other forest values, cattle, crops)
  • compare alternative timber species
  • compare silvicultural treatments
  • determine the cost effectiveness of commercial thinning
  • determine the optimal rotation age
• Information Needed for a Financial Analysis

  Investment Period

  In any investment, you must know the time period.  In southern pine timber management, commonly used time periods are 30 years or more.  Some pine stands can be cut for pulpwood at 15 to 20 years.  Holding the stand for a longer rotation can result in products of higher value (i.e., sawlogs) and usually a higher rate of return.  When growing sawtimber, thinning at about 15 years of age will produce periodic income and shorten the time needed to produce higher value products.  See our Thinning page for more information.

  Note: You should compare the costs and benefits associated with different rotation ages and choose the rotation age that is most cost effective.

  Costs

  The major costs involved in establishing a pine plantation are those associated with site preparation and buying and planting seedlings.  These costs usually range from about $200 to $400 per acre.  If you want to establish a pine stand from seed, the costs will depend on the amount of work needed.  For more information on the types of treatments involved in southern pine timber management, see our Timber Management section.

  Annual management costs are usually those associated with firebreak maintenance and are usually minimal for the first 15 to 20 years.  Property taxes must also be accounted for in the analysis.  Property taxes are usually taxes on the land and must be paid whether or not you are producing any kind of crop.

  Selling Price

  You need to know what price to expect for the trees you will sell, known as stumpage price.  Stumpage price is the price paid for trees as they stand in the forest.  Each product (sawtimber, poles, pulpwood) has its own stumpage price.  Unfortunately, you must project the selling price of the products you plan to grow 15, 20, or 30 or more years from now (depending on the product) at the time the trees are harvested.  The current stumpage price, inflation rate, and past price trends are all considered in making this estimation.

  In addition to determining the future selling price of the products you intend to produce, you must also determine your forest's growth and yield.  See our Growth & Yield page for information about measuring .

• The Financial Analysis

  The Time Value of Money

  Financial evaluations can be of two types:

  1. those that recognize the time value of money
  2. and those that do not

  The "time value of money" is simply an account for the notion that a dollar today is worth more than the same dollar 10 years from now.  When you get a dollar today, you can spend it immediately if you wish.  If you get a "promise" for a dollar instead of the dollar itself, you must wait.

  Due to the uncertainty involved in the wait (i.e., the loaner changes his or her mind, dies, or inflation continues at its current rate) the dollar received is worth more than the promised dollar.  This brings us to the concept of interest rates.

  Interest Rates

  Measuring the value of money or capital involves 2 important factors: 

  1. time
  2. quantity

  The cost of keeping money in a project, in our case a forestry project, is indicated by the interest or discount rate.  As the old saying goes, "time is money". Time costs money as do other inputs and the price of time is usually measured by the interest rate. In general, projects with a longer life require higher discount rates.

  Investors know that money can be made by lending money.  People are willing to pay for the use of money.  When an investment grows at a specified interest rate, we call it compounding.  $100 invested at 5% for 5 years will yield $127.63 at the end of the 5 years.  To determine this, we multiply $100 by 1.05 in year one, again in year 2, and so on up to year 5.  This process can be simplified by using the formula:

  Vn = Vo (1 + i)n

  Where:

  • Vn =  the value at the end of the investment period
    Vo = value at the beginning of the investment
    i = interest rate
    n = number of periods (years) - this is an exponent in the formula

  So, referring back to our example, the above formula is applied:

  V5 = $100 (1.05)5 = $127.63

  This same relationship can be used in another common function which is the opposite of compounding: discounting.  Discounting begins with a future amount and determines its worth today.  Using our example above and some basic algebra, today's value of a payment of $127.63 received in year 5 would be found using the formula below:

  Vo = Vn / (1 + i)n

  Using this formula, we can plug in our numbers:

  V0 = $127.63 / (1.05)5 = $100.00

  There are a number of other more complex formulas used to calculate different types of terminating and infinite series of payments or costs.  Some of these are introduced below and in other extension publications that are linked elsewhere in this section.

  Which Interest Rate Should You Use?

  There are 2 types of interest rates: 

  1. real rate - does not reflect inflation
  2. nominal rate - does reflect inflation

  A nominal interest rate is calculated by incorporating both a real rate and a general inflation rate using the following formula:

  Nominal Rate = [(1 + Real Rate) × (1 + General Inflation Rate Per Period)] − 1

  This formula can be manipulated to give us the real rate if the nomimal rate and general inflation rate are known:

  Real Rate = [(1 + Nominal Rate) / (1 + General Inflation Rate Per Period)] − 1

  Economists generally use the real rate because it gives a clearer picture of the project's true worth. You should be sure that your analysis is based on several appropriate real discount rates.

  Net Present Value (NPV)

  Net Present Value (NPV) (or Present Net Worth (PNW)) recognizes money's time value by using the minimum acceptable rate of return (determined by you) to discount all costs and returns back to the time of project initiation (period 0 or period 1, depending on the timing of cash flow).  The discounted costs are then subtracted from the discounted revenues as shown below:

  NPV = Present Value (Revenues) − Present Value (Costs)

  For more information, view a sample NPV calculation for a hypothetical timber management scenario.

  Internal Rate of Return (IRR)

  The Internal Rate of Return (IRR) shows the investment's actual rate of return.  The IRR is the discount rate when the present value (PV) of the costs is equal to the PV of the revenues, or when NPV equals zero.  The IRR is calculated using an iterative process to solve for the appropriate rate.  A spreadsheet program is a very useful tool for this type of calculation. 

  A project with an IRR smaller than your minimum acceptable rate of return (MARR) is less profitable than one with an IRR greater than your MARR.

  NPV and IRR are the two most widely used and accepted decision criteria.  Many investors, particularly nonindustrial private forest landowners are most comfortable with IRR because the final result is an interest rate.

  Benefit / Cost (B/C) Ratio

  Another way to use the present value of the costs and revenues to determine the present worth of a project or investment is the benefit/cost (B/C) ratio.  Here, we simply divide the present value (PV) of the revenues by the PV of the costs:

  B/C = PV Revenues / PV Costs

  This calculation gives you a "bang for your buck" estimate. A B/C value greater than one indicates that discounted benefits exceed costs. A B/C ratio less than one indicates that discounted costs exceed benefits. This ratio is often used to evaluate projects on public lands.

  Equal Annual Equivalent & Land Expection Value

  Equal Annual Equivalent

  The Equal Annual Equivalent (EAE) is simply the Net Present Value (NPV) converted to an annual value paid at the end of each year or period for the life of the investment.  It is calculated at the appropriate discount rate using this formula:

  EAE = NPV [(i(1 + i)n] / [(1 + i)n − 1)]

  Where:

  • i = interest rate 
    n = number of periods (years) - this is an exponent in the formula

  Land Expectation Value (LEV)

  Finally, the Land Expectation Value (LEV) (or Soil Expectation Value (SEV)) is the present value of all future costs and revenues of a productive asset.  Put simply, it is the value of bare forest land.  Calculating LEV is similar to assuming that a project will be replicated an infinite number of times into the future.  This makes all projects have an infinite time horizon. 

  The LEV is useful for estimating the bid price of bare land for growing successive rotations of even-aged timber.  Land purchase costs and land sale returns are not included in the calculation of LEV.  LEV is the net present value (NPV) for an infinite time horizon.  It is calculated using this formula:

  LEV = NPV (1 + i)n / (1 + i)n − 1

  Where:

  • i = interest rate 
    n = number of periods (years) - this is an exponent in the formula

  ---

  Sample NPV Calculation

  Following is a net present value calculation for a hypothetical timber management scenario.  In this example, site preparation and planting take place in year 0 (now).  A weed control treatment is conducted in year 1.  A precommercial thinning, yielding no revenue, takes place in year 15.  There is an annual administrative cost of $5.00 per acre per year.  A commercial thinning takes place during years 40 and 50 and the stand is clearcut at age 60.  All cash flows take place at the beginning of the year.  A real discount rate of 5% is used. 

  Step 1. Discount all costs.

  Activity	Discounting Formula	Present Value ($/acre)
  Site Preparation Planting Weed Control	−$50 −$100 −$50(1/1.05)	−$50.00 −$100.00 −$29.29
  Precommercial Thinning	−$50(1.05)15	−$24.05
  Annual Administrative Cost	−$5 { [(1.05)59−1] / [0.05(1.05)59] } + $5*	−$99.38
  Total Present Value of Costs		−$302.72

  *If uniform series of payments occurs at the beginning of each year then this formula is used:

  V₀ = a { [(1 + i)n − 1 -− 1] / [i(1 + i)n −1] } + a

  Where:

  • a = periodically recurring cost or revenue at the beginning of each period
  • V₀ = present value
  • n = number of periods (years)
  • i = interest rate

  If these payments occurred at the end of each year, the formula would simply be changed to:

  V₀ = a { [(1 + i)n − 1] / [i(1 + i)n] }

  Step 2. Discount all revenues.

  Activity	Discounting Formula	Present Value ($/acre)
  Thin at age 40	$500(1/1.05)40	$71.02
  Thin at age 50	$1,500(1/1.05)50	$130.81
  Clearcut	$2,500(1/1.05)60	$133.84
  Total Present Value of Revenues		$355.67

  Step 3. Subtract discounted costs from discounted revenues.

  Net Present Value =

  $355.67 − $302.72 =

  $32.95

  (From Rose et al, 1988)

• Additional Resources

  What Is the Value of an Existing Forest Stand?
  This publication provides the formula to determine the value of an already established forest stand at any stage of its development. This approach, known as the forest value formula, includes the value of the timber and the land.

  Determining the Net Present Value of Timber Investments and Comparing Investments of Different Rotations
  Accurate economic valuation is essential for comparisons of different pine or hardwood species rotation ages and/or different management intensities, as well as to determine the insurance value of a forest. Another important purpose of an economic assessment is to compare different timberland investments. This is particularly important when timber management projects have different time horizons. 

  The Optimal Forest Management of an Even-Aged Stand: The Biological Rotation versus the Land Expectation Value
  This publication provides a guide for forest landowners, managers, and stakeholders in conducting a valuation of timber investments. We will review and provide examples of two different approaches for determining the optimal rotation age of even-aged forest stands: the biological rotation, the single rotation and the land expectation value.