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
Weighted Average Price, Quality Stand
0
100
200
300
400
500
600
70057
59
61
63
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
95
97
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01
03
05
Year
$ p
er
MB
F
Nominal
1982 $’s
Trend line – 1.4%
Indiana Farm Real Estate
0
500
1000
1500
2000
2500
3000
3500
Year
$ pe
r A
cre
1982 $’s
Nominal $’s
Trend line - 1.3%
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
-6.00
-4.00
-2.00
0.00
2.00
4.00
6.00
8.00
10.00
12.00
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
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
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)i = ($324,800/$175,250)1/25 1/25 -1 = 7.4%-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