The Swedish Stand Method as an Income Capitalization Approach in Forest Property Valuation Baltic Valuation Conference 2013 Reykjavik, Iceland September 2013 Gunnar Rutegård Lantmäteriet - the Swedish mapping, cadastral and land registration authority

Non-industrial forest ownership in Sweden 22.5 million hectares of productive forest land (55 % of Sweden´s total land area) About 328,000 non-industrial private owners own 50 % of the forest area, divided into 238,000 management units

Private forest ownership Most common way to acquire a forest property is as gift or purchase within a family or by inheritance The number of representative, market based purchase can be estimated at be about 1,000 – 1,500 transactions per year Reasons for the need for valuation of forest properties (compare with Finland), e.g.:  Acquisitions in the open market  When forest areas, due to their natural (biological) values, are taken over or when restrictions are imposed on forest management by the State  In conjunction with a transfer within the family  In dissolution of co-ownership  When forest is to be taken as security for a loan

Some characteristics of Swedish forestry properties The financial value of forest is primarily based on the income from timber production The long time that must elapse before the forest is ready for harvesting The annual felling volumes can vary greatly between years => the smaller a forest property, the greater is the likelihood that age class distribution is not evenly spread which also affect revenues

The market situation for forest properties Until the latter part of the 1980s, the market was very much regulated; active farmers were given priority to the nearby forest - a price review was done in order to avoid prices exceeding the estimated long-term rate of return About 1990 there was a liberalization of the institutional framework; forest properties could be sold on market terms => Increased supply of forest properties

Gross value and net conversion value of annual felling, and prices for forestland, , in real values at 2012 prices

Probable reasons behind this trend reversal Many buyers are prepared to pay handsomely for so-called non-monetary components, e.g.  sentimental motives  attachment to the geographical area  right of control  pride of ownership Buyers do not have the same requirements as previously concerning a high yield from the property in order to handle their finances Lower interest rates at the time of joining the EU (1995) Long-term return from the forest to balance risks on the stock market The tax reform 1992

The Stand Method Was introduced in 1989 Is the predominant method for valuation of forest properties in Sweden Lantmäteriet has the responsibility for the maintenance of the method Has about 200 users in Sweden – the largest category of users is to be found within the Swedish Forest Agency but some of the users are also small, private businesses (consultants)

The Stand Method Is based on the classical approach of income simulation of market value Handles each stand separately – the stand is extrapolated, based on the field conditions estimated by the valuator Inventory data includes:  area, distance from road for timber extraction (logging), site quality, age, maturity class, species composition, volume of growing (standing) forest and planned silvicultural measures Activities such as thinning, final cutting and silvicultural measures are simulated and extrapolated from the time of valuation to the final felling

The Stand Method Revenues and costs are discounted to the present day, according to the applied discount factor At the end of the first rotation period, a forecast is made for an ideal production for an additional rotation period This ideal production is repeated an infinite number of times The final net present value is represented by the value of the current rotation period plus all future rotation periods

The Stand Method An example of the principle The bars symbolize the revenues and costs

The applied discount rate The user determines the discount rate that is to be applied, which is very important for the final net present value Lantmäteriet publishes guidelines for the discount rate that should generate a fair market value This recommended discount rate is an average for the country and is estimated based on a number of fictive type forest properties with varying conditions When the discount rate began to be used the recommended interest rate was 4-5 per cent The recommended rate for the year 2013 is 2.5 per cent How could this successively falling discount rate be justified from an investment perspective?

The applied discount rate The discount rate in the Stand Method:  will be used as a part of the process to simulate the market conditions  should reflect the average long-term relationship between future timber yields and prices paid for the properties  can be seen as an average market-steered interest rate designed to reflect the long-term benefits of timber yields  the rate used (determined) will thus take into account the market´s perception of the value of forest stands of different age  should not be treated as an ordinary hurdle rate applied in a standard cost-benefit calculation

The use of the Stand Method as guidance for valuation of forest properties The recommended discount rate will only give some indication => the individual user of the method should find a more precise level of interest rate that matches his/her field of activity A method recommended is to start from a number of sales of forestland, which occurred within the user´s field of activity, over a limited, but current, time period The sold properties should have a forest plan with inventory data => Input the inventory data into the Stand Method program => Run an iterative adjustment of the discount rate until the level that corresponds to the price at which the property was sold for is found => The determined rate can be used as an input for new valuations

Based on two valuation methods Is it correct to say that the Stand Method is based on two separate valuation methods? It definitely uses the Income Capitalization method, including market-related discounting cash-flow To obtain a market value, the result of the I C calculation may not be adequate if not in accordance with the local market => the user´s knowledge is very important in this context

Based on two valuation methods Adjust the discount rate - this adaptation of the valuation to the market is a way of using the Sales Comparison method  The Stand Method make use of both the Income Capitalization method and the Sales Comparison method