Economics of Timber Production on Private Land in Indiana

1. Economics of Timber Production on Private Land in Indiana

2. 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

3. Weighted Average Price, Quality Stand Nominal 1982 $’s Trend line – 1.4%

4. Black Cherry Sawlogs, Real

5. Beech Sawlog Prices, Real

6. 1982 $’s Trend line - 1.3% Nominal $’s

7. Economics or Finance? • Finance • Capital intensive • Land • Growing stock • Long-term • Highly appreciated

8. 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

9. 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

10. 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

11. Real Interest Rate, 10-Yr. Treas. Sec., 3-Yr. Moving Average

12. 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

13. Operating Costs • Allocate between personal and business use • Property taxes • Management fees • Depreciation on equipment • Other

14. 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

15. 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

16. 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

17. 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

18. Base Case, WPL, No Bequest – Liquidate • WPL40 = $1,755 per acre, real • WPL40 = $2,845 per acre, nominal

19. Base Case, WPL, Bequest • WPL40 = $755 per acre, real • WPL40 = $1,208 per acre, nominal

20. Barton Tree Farm (BTF) • Acreage – 292 • Initial acquisition in 1980 • Acquisition cost - $175,250 • Total timber revenue - $324,800

22. BTF Initial Cost and Timber Revenues

23. BTF Rate of Return, No Expenses, Bequest • No operating or holding costs included • i = ($324,800/$175,250)1/25 -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

24. 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

25. No Bequest, Liquidate • $15.05 per acre per year cost • Sell land for $1,500 per acre • $438,000 • Sell 2,354 MBF timber for $660/MBF • $1,553,640 ($5,320/acre) • IRR • Before tax – 10.8% • After tax – 10.2%