Mixed Signals

By Dave Skinner

In 2000, America's stressed forest-products sector was in the early stages of a multi-million-acre sell-off of commercial forest lands to non-industrial, "institutional" investors including, but by no means limited to, the Hancock Timber Resource group, a subsidiary of John Hancock Insurance.

In response to this trend, the U.S. Forest Service and the Pinchot Institute for Conservation jointly convened a symposium in May of 2000. The symposium focused primarily on the conservation implications stemming from the fact that institutional investors "respond to different signals than do forest products companies."

Conservation groups, mainly land trusts, were concerned the changing fiscal landscape would not only impact the physical landscape, but would also create a business climate in which the task of conserving significant acreages with potentially high ecological value would become increasingly difficult.

In late 2001 the Pinchot Institute published a 58-page primer titled "Industrial Timberland Divestitures and Investments: Opportunities and Challenges in Forestland Conservation," in which Institute staff writers, Nadine E. Block and V. Alaric Sample, assessed the goings-on. Nearly 10 years have passed since their report was published, and it is still worthwhile reading for anyone wanting to know how Real Estate Investment Trusts (REITs) and their counterpart Timberland Investment Management Organizations (TIMOs) have utterly changed the context of forestry and forests in America.

Block and Sample do a good job of describing how the institutional investment sector is a different beast than the forest industry. Much of their discussion about REIT's, TIMO's, pension funds, and taxation is essentially correct, a good basic knowledge platform.

But their report is also a textbook case of how difficult it is to predict the future, even when you have the general concepts mostly correct. In fact, there is a strong sense of déjà vu all over again for today's reader.

For example, Block and Sample predict that "12-15 million acres of industrial timberlands in the US will be transferred out of industry ownership during the next decade." The actual number is, depending on whom you ask, roughly 50 to 70 million acres bought and sold.

Moreover, the authors failed to fully grasp the importance of the REIT/TIMO "class" of ownership - although they did note "unless there are significant changes in corporate income tax laws, the rate of return on a given acre of US timberland will always be lower for an integrated forest products company than for a timberland investment management organization (TIMO)."

In hindsight, the impact of taxation laws, specifically changes stemming from the Real Estate Investment Trust Simplification Act (REITSA) of 1997, has been gigantic, a complete game-changer. One could argue that Block and Sample's crystal ball was clouded somewhat by the motives of its sponsors. After all, just as timber beasts and institutional buyers "respond to different signals," so too do conservation groups and government agencies. Furthermore, even when the signals are the same, the responses are often different.

But there is one signal to which all players will respond: money. And the response to money is always the same: Try to get more. This is the report's real worth to today's reader. Its conservation and agency participants read the signals and their response was, in short: "Throw more taxpayer money at our problem."

Of course, the authors were a bit more subtle: "If the public values these lands have historically provided are to be maintained, then public funding and support, as well as new strategies, are critically needed to conserve these lands and ensure their current and future stewardship."

On the private side, the signal was the tax code, and the response was monumental, the creation of an entirely new commercial forestry business model. But when all is said and done, the signal and response remains precisely the same as it has always been: Throw more money.

The private-sector entities that participated in the Pinchot symposium were receptive to taxpayer funded partnerships aimed at "conservation." Herein, Block and Sample's discussion concerning sales of sensitive land is enlightening:

"If a sale can be made at or above fair market value [italics added], most TIMOs can improve their financial performance by selling such assets. Frequently, environmentally sensitive properties are difficult to operate and are poor cash generators. Selling these properties unlocks or 'monetizes' their conservation values. These values are frequently higher than their operational values."

Get the signal? If you don't, or don't know what your response should be, perhaps you will after reading Block and Sample's report.

Click on PDF below read the Pinchot Institute's 2001 report

Pinchot Institute - 2001

Click here to go to "Notes From All Over" and Andrew Bary's August 10 report in Barron's