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
700
600
Nominal
400
1982 $’s
300
Trend line – 1.4%
200
100
Year
05
03
01
99
97
95
93
91
89
87
85
83
81
79
77
75
73
71
69
67
65
63
61
59
0
57
$ per MBF
500
Black Cherry Sawlogs, Real
1600
1400
1000
800
600
400
200
Year
5
02
99
96
93
90
87
84
81
78
75
72
69
66
63
60
0
57
1982 $'s per MBF
1200
Year
5
02
99
96
93
90
87
84
81
78
75
72
69
66
63
60
57
1982 $'s per MBF
Beech Sawlog Prices, Real
250
200
150
100
50
0
Indiana Farm Real Estate
3500
3000
2000
1982 $’s
Trend line 1.3%
1500
1000
Nominal $’s
500
0
19
57
19
60
19
63
19
66
19
69
19
72
19
75
19
78
19
81
19
84
19
87
19
90
19
93
19
96
19
99
20
02
20
05
$ per Acre
2500
Year
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



Some vertical integration
Not attractive to institutional investors and
private equity capital



Cost of entry may exceed income potential
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
V0 = Vn/(1+i)n
Internal rate of return

Discount rate that makes NPV zero
NPV Calculation

Enter land and timber growing stock as upfront 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
12.00
10.00
8.00
6.00
4.00
2.00
-4.00
-6.00
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
-2.00
1964
0.00
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


WPL40 = $1,755 per acre, real
WPL40 = $2,845 per acre, nominal
Base Case, WPL, Bequest


WPL40 = $755 per acre, real
WPL40 = $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
1980
-$175,248.00
1984
$11,313.00
1985
$11,678.00
1988
$9,503.60
1990
$14,323.35
1995
$21,951.08
1997
$61,746.95
1998
$387.91
1999
$85,300.00
2001
$70,102.00
2005
$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


Sell 2,354 MBF timber for $660/MBF


$438,000
$1,553,640 ($5,320/acre)
IRR


Before tax – 10.8%
After tax – 10.2%