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 Nominal 1982 $’s Trend line – 1.4%

Black Cherry Sawlogs, Real

Beech Sawlog Prices, Real

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

Economics or Finance? Finance  Capital intensive Land Growing stock  Long-term  Highly appreciated

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  V 0 = V n /(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

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 WPL 40 = $1,755 per acre, real WPL 40 = $2,845 per acre, nominal

Base Case, WPL, Bequest WPL 40 = $755 per acre, real WPL 40 = $1,208 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 $175, $11, $11, $9, $14, $21, $61, $ $85, $70, $38,500

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

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

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%