Forest Investment and Financial Planning Fact Sheet

High Country Forestry

Forest Investment and Financial Planning

Forestry cashflows
Forestry investment involves site preparation costs, tree establishment costs, and tending costs usually occurring within the first third of a rotation (eg a total outlay of $3,500 per hectare, including overheads for 60 year planted Douglas fir). This is followed by a long period of growth where only annual indirect costs such as insurance and rates are involved, climaxing in a usually quite lare gross revenue when the crop matures (eg $60,000 per hectare or more for 60 year old well located and grown douglas fir).

At first glance, this looks impressive, but consideration must also be given to the time involved before this investment return is achieved.

Returns on investment - what they mean
Many forestry investors express the cashflow of a forestry rotation in terms of a return on investment (eg internal rate of return, IRR). A forestry investment on good sites close to ports will generally show a projected rate of return of between 6% and 9%. That is, a yearly compound increase of 6% to 9% on the value of the investment: ($1,000 + 8% = $1,080 in year one; $1,080 + 8% = $1,166 in year two; $93,756 + 8% = $101,257 in year 60). Well planned high country plantings would probably achieve rates of return in the range of 2% to 7%.

Most people immediately compare this to a bank deposit rate. This is wrong. The forestry return is a real return and is not eroded by inflation as interest deposit rates (nominal rates) are. Forestry has historically protected the purchasing power of the investment as revenues have risen at least in line with, but actually between 1% and 2% above, inflation. Forestry is a hedge against inflation.

The second major consideration is how tax affects the return. Interest deposits are taxed annually on the total earnings of the deposit (ie including that amount necessary to maintain the purchasing power of your investment). Forestry returns are not taxed until sold or harvested. Tax has a considerably lesser effect on post-tax forestry returns than interest returns. Therefore forestry is a partial hedge against taxation rate changes.

As an example, if inflation increases dramatically and marginal tax rates are high, the real post-tax returns from interest (eroded initially by tax, then by inflation) can be very low or negative. Provided a forestry block is well planned, the increase in inflation and tax rates will still ensure a reasonable forestry return.

Other benefits to forestry investment for farmers;

You own the land; unlike outside investors. If land chosen for forestry has a low long term carrying capacity and high costs associated with retaining it in pasture, the opportunity cost of planting trees can be considered low or negative.
Expenditure on trees comes out of Gross Farm Income. Expenditure on any off-farm investment (stocks or interest) comes out of tax paid revenue. Because most forestry expenditure is tax deductible in the year it occurs, a farmer can spend $3.00 in forestry for every$2.00 invested in interest or stocks.
Most forestry expenditure is in labour. Chemicals, tree stocks, and pruning and thinning equipment are the only notable exceptions. Farmers with surplus seasonal labour can substitute capital with labour. This is particularly important where farmers have a major limiting resource of off-farm capital, but available labour.
With marginally costed land an labour the returns to the limiting resource of off-farm capital can be very large indeed.
The Forestry Rights Registration Act (the act empowering forestry joint ventures) enables you to sell the land, either within our outside the family, and still retain the trees to harvest as you require throughout your retirement.
The harvest date is discretionary. Where agricultural products have a limited time span within which they can be marketed, forestry stands can be liquidated within a time frame spanning decades. A farm with mature trees, and an even distribution of age classes back to establishment , is an extremely strong economic unit. Trees on farms are a good risk management strategy to take advantage of agricultural cyclical lows, to safeguard far equity and avoid tax on forest revenue.
Forest value is based upon a growing, non depreciating product: - wood. This not only constitutes a hedge against inflation, as historic wood prices, and future trends, move with inflation, but, additionally, the value is not subject to the vagaries and emotion of stock prices.
Some considerations of forestry for farmers
Funding a forestry project:
A forestry investment, starting from bare land, will take decades to come on-stream. During this period the investment is unable to service its own expenditure. Expenditure must be serviced out of alternative income (equity) or debt. The inability for a forestry project to service debt means that this financing option has a greater risk, and should be treated with caution, particularly if real interest rates are high.
Besides debt, the major funding options are from farm income, substituting farm labour or off-farm investors. Legal mechanisms are available to enable off-farm investors to share the expenditure in a forestry project, thereby retaining a right to an equivalent share of the revenue (see Joint Ventures).
Budgeting:
The most important forestry expenditure occurs early in the rotation, particularly during establishment. This may involve some mechanical and/or chemical preparation of the site prior to planting, expenditure on tree stocks and planting, and some post planting weed control. Cutting establishment costs can jeopardise the whole operation, and quality should always be an important consideration when choosing contract prices.
Further important costs occur during tending in the early part of a stand's development. Non operational costs may occur at any time during the rotation (eg consultant's reports, insurance, etc).
Establishing and tending a forestry project should be planned to avoid funding or labour constraints in the future. This is particularly important where projected off-farm capital is limited, or the management regime chosen is intensive and therefore less amenable to delays in tending. Planning is a simple process requiring very little effort. But it can mean the difference between success and failure.
Forestry Risks - How significant are they?
Many individuals focus on the risks they perceive in forestry.

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