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It Looks Like Your Father Was Right: Money Doesn’t Grow On Trees

If they have been half listening, owners of timberland in Vermont may be feeling good these days about the value of their holdings. Prices for stumpage are rising, mills are expanding their capacity, and demand for Vermont timber is strengthening at home and abroad, according to recent reports.

Then, too, there's news that well-capitalized companies have been buying substantial tracts of timberland in Vermont and that professional investors claim they are getting annual returns from timberland exceeding 10%. No wonder so many timberland owners feel they are sitting pretty.

Their big temptation: cash in. Newer owners may well be hoping for a bonanza and long time owners may well be expecting solid rewards after years of waiting.

Not so fast, say cautious industry officials and experienced owners of timberland.

They point to the realities of timberland ownership in Vermont, among them high property taxes, unproductive woodlots, high cost of management, reluctance of loggers and mills to pay top dollar for standing timber, and long timeframes to realize real return.

Add these negatives to the lack of sophistication of many owners about how to make the most of their holdings, together with the potential damage to the longer term health of the forest if harvests are rushed. And the upshot is a frustrating situation for many timberland owners in the state.

Just when things seem good, they aren't. Get out pencil and paper and most owners will find (if they are honest) that even under improving circumstances they are actually breaking even or losing money on their timberland.

That will not concern three out of four of the roughly 60,000 owners of timberland in the state. Their woods are part of their home or valued for natural beauty, wildlife or recreation; they use their wood for their own purposes, chiefly firewood; and they are delighted with any cash that comes their way from timber sales. Figuring out profit and loss is largely irrelevant.

Thousands of private timberland owners, however, do count their dollars carefully, yet, according to industry officials, only a fraction are doing the accounting and making the moves that ensure they will truly make money.

What Makes It So Difficult?

Talks with state officials, private foresters, landowners and professionals in the field bring out dozens of the complicating factors. High on the list is the timeframe of owners. Many are unwilling to wait the years, even decades, for their forest to mature to ideal harvestable levels and so may cut timber before it is ready, thereby missing maximum income potential.

Then there are the uncertainties of the marketplace. It can frustrate even the most prescient owner trying to match personal needs with changing fashions in wood products and changing economic cycles (demand for sawlogs fluctuating with housing starts, for instance).

The complex nature of woodlands in Vermont does not make it easy for the amateur, either. Take the diversity of trees. A dozen or more species may grow on a single acre, each with its own life cycle and market. Sites vary from flat, fast-growing, easy-to-reach locations, where productivity is high and operating costs relatively low, to hilly, slower-growing, hard-to-reach sites, where productivity is low and operating costs relatively high. Many woodlots have seen heavy cutting where the best trees have been hauled off, leaving the owner no choice but to wait years for recovery.

A key assumption throughout this article is that forests are harvested at so-called sustainable yield, i.e., trees are growing faster than they are being cut. Do the opposite—cut the best trees in a once-in-a lifetime blowout — and the guidelines here are worthless.

Some Guidelines For Making Decisions

For all these variables, what constants can guide decision-making by owners of small to medium size timberlots? Authorities on timber and management urge owners to consider these four at least: cost of land; revenue from timber sales; stumpage prices; management expenses; and property taxes. Let's look at a hypothetical owner of a 100-acre plot:

Cost of land: How much should an owner pay for timberland in Vermont, if he or she expects to make a reasonable return based on today's market conditions? While answers depend on productivity of the site and the species of trees, authorities question paying more than $ 100 per acre, based on guidelines from the Vermont Current Use Advisory Board.

It recently set $79 per acre as a reasonable price for an investor to make GV2 percent net annual return on an investment, after taxes and management expenses. The more harvestable timber on a site, of course, the higher the current value of the property.

Revenue per acre: How much gross revenue per acre might a landowner expect to average each year from timberland if the land is held for many years? Estimates range from as low as $5 per acre per year for less productive sites to $ 16 per acre per year for well-managed forests on productive land.

Based on current stumpage prices, gross revenue might average between $9 and $10 per acre before management expenses and taxes. At $9 per acre an owner of 100 acres might expect to gross $9000 in ten years.

Management expenses: How much might an owner expect to pay to manage timberland if expenses are added up and averaged over a cutting cycle of ten years or more? Expenses would include the cost of preparing a management plan, putting in roads and landings, as well as tracking boundaries, marking trees for cutting and supervising cutting. Estimates vary but the most widely quoted numbers range between $1.50 and $3 per acre per year. At $2 per acre per year, expenses for a 100 acre woodlot would amount to $2000 over ten years.

Property tax: This is much the most variable and controversial expense connected with owning timberland. The two biggest factors are: first, the location of the property since the more remote and farther north in Vermont, generally the lower the taxes per acre; and second, whether the owner has enrolled in the Vermont current use program, which can lower property taxes.

If you pay $2 or less per acre per year in property taxes, you might well make money over a 30-year cutting cycle, estimated one authority. Others see a higher profitability level, permitting payments of as much as $4 or $5 per acre per year in property taxes. However, owners say they have had to shorten the cutting cycle (often below a sustainable level) to pay taxes at this higher level. At $4 per acre per year, property taxes for 100 acres over ten years woul d amount to $4000, which doesn't take into account lost return from investing this money otherwise.

Federal and state taxes: Under current federal tax law owners who actively manage their timberland can treat timber sale income as long term capital gains, which have a maximum tax rate of 28%. Assume an owner received $9000 from a sale (based on $9 per acre for 100 acres for ten years). Based on a zero cost basis, the federal tax could amount to as much as $2520, and that doesn't include payment of Vermont income tax.

Adding It All Up

So what is the return for this theoretical landowner? On paper, he or she is left with a gross profit of $480, based on revenue of $9000 minus expenses of $8520. And that calculation does not include the purchase cost of the land nor the so-called lost opportunity cost (if the money had been invested in other ways).

The point is not these absolute numbers, which are used for example only, but the process they illustrate, and more importantly, say timberland authorities, the difficulty in predicting future returns given the many variables.

How Do The Professionals Do It?

Hard as it is, professional investors and some timberland owners do make money and do get competitive returns (8% to 10% and more) from their holdings. What's their secret? The keys, they say, are: long timeframes, up to 30 years, rising stumpage prices, careful management and finding other ways to realize revenue from their timberland.

Natural growth rates: Professionals assume annual growth rates of three to four percent in wood volume per acre per year, again depending on site and species.

Managed growth rates: The trick is to manage the forest to add two or three percentage points to the annual growth rate through selective thinning and waiting. The goal: let the best trees reach their maximum value. A hardwood that reaches 10 to 11 inches in diameter jumps in value as much asfourtimes over a tree just one or two inches smaller. Let that tree grow to 16-18 inches in diameter, which may take 30 years or more, and the value can jump four and five times again. No game for the impatient.

Growth in stumpage prices: Overall, stumpage prices for sawlogs of Vermont softwoods and hardwoods, if averaged over many years, do rise as much as one or two percentage points above the rate of inflation, according to USD A estimates. Stumpage prices on selected species can shoot up sharply, too, most recently illustrated by a doubling of the price for clear maple during the last three years, ending a long stagnant period.

This rate has been accelerating recently, lifting prices for Vermont sawlogs to a higher plateau, according to authorities. In addition, demand for Vermont sawlogs is diversifying, expanding the market for different species (maple, cherry, even poplar), which bolsters their prices. On the other hand, prices for pulp and firewood have tended to average downward over the past 15 years.

Add those three percentages (3 to 4 percent from natural growth; 2 to 3 percent from managed growth; and 1 to 2 percent from real gain in stumpage value) and professionals argue that over time — at least 10 and as much as 30 years — they can average annual inflation-adjusted returns per acre of 6 percent or better.

The Bottom Line

Thousands of Vermonters have realized substantial cash flow and real profits from their timberland. And thousands more expect to, buoyed by the recent upturn in the state's timber economy. Longer term, however, it is usually the disciplined, patient owner who has the best chance of getting a respectable return. They appreciate the power of time and can operate in four dimensions at once.

A Better Chance At Breaking Even

Besides harvesting trees, owners of timberland can improve their economic lot through other means, among them:

  • Current Use. Enrolling in the Vermont current use program can reduce taxes for some owners.
  • Easement. Owners can reduce out-of-pocket annual expenses for federal and state income taxes by giving away development rights to some or all of their timberland, or by selling those rights.
  • Leasing. Leasing rights for hunting, camping and other recreation can generate revenue, but generally this works only for owners of larger tracts.
  • Land sales. Finally, owners can sell portions of their land, which is rarely a popular choice, but one that has kept the bulk of many a property intact.

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