Timber is a desirable asset class for several reasons. First, timberland has historically generated excellent returns. Second, timberland historically has a low correlation with other major asset classes, therefore, providing portfolio diversification. Third, timberland returns have been positively correlated to the rate of inflation, which creates a hedge for the portfolio. Finally, including timberland in a diversified portfolio can increase total return at commensurate levels of risk.
Timber beats stocks and real estate.
Managed timber (as professional investors call it) has actually beaten the stock market – with less risk – over the long run. From 1973-2002, managed timber returned roughly 15% annually as an investment, while stocks returned about 11%. Timber has also beaten real estate even though real estate packed quite a punch between 2001 and 2006, appreciating 12.4% annually, according to the S&P/Case-Shiller U.S. Home Price index. A study by Jack Clark Francis, a finance and economics professor at Baruch College in New York City, and Yale’s Roger G. Ibbotson compared the annual returns of real estate from 1978 to 2004. The results? Housing delivered a solid but unimpressive annualized return of 8.6%. Commercial property did better at 9.5%. Other studies argue that real estate’s returns are much worse. Yale finance and economics professor Robert Shiller, author of Irrational Exuberance, who looked back to 1890, contends that only twice has real estate produced truly outstanding returns: after World War II, when returning troops were starting their families, and from 1998 to 2005, a period he thinks was a bubble. Housing’s rate of return, he argues, has to trend back to the mean of about 3% a year – barely above the inflation rate. If that’s starting to happen now, he says, we could be facing many years of losses. Looking forward over the next decade, it seems highly likely that real estate investment returns could have a tough time comparing with those of the stock market, but are sure to fall well below those of timber investments.
Timber is uncorrelated to stocks.
Trees don’t know about the war against terrorism, or the bear market in the Nasdaq. While stocks couldn’t keep up with inflation in the 1970s, timber investments never had a losing year! Trees just keep growing year after year. So investing in timberland is an excellent way to balance your portfolio as its value rises even when stocks are falling.
The price of timber has consistently beaten inflation. Think of your timber investment as a good inflation hedge – the numbers show that to be true. According to legendary investor Jeremy Grantham, over the last century, timber prices have risen at 3.3% above the rate of inflation. Add 5% a year in income, and you’ve got a timber investment asset that has returned double digits.