In-house and collaborative research underlies nearly all of our investment decisions. We write and produce several research documents on a regular basis. These publications are used to educate potential investors, while keeping our current clients informed of topics that may be relevant to their portfolio.
Impact of Shutdown on Timberland and Farmland
Timberland
We believe the extended federal government shutdown will be very limited in meaningful, direct impacts on the U.S. timber or forest products sectors. On the supply side, timber harvests on U.S. federal forests have not been a significant or consistent source of raw material to producers of lumber, wood panels or pulp since the early 1990s. In addition, restricted federal services are not likely to result in major impediments to the production or transport and sale of timber and forest products domestically, since most of the regulatory governance of the timber and forest products industries is at the state and local level, with limited oversight by the federal government. The federal government does have a significant role in funding forest fire control efforts (primarily in the western U.S.), but this will probably not be a major concern given the timing of the shutdown in the winter, when fire risk is near zero.
The escalating trade dispute between the U.S. and China has been a headline issue for most of 2018. Until the latest round of tariffs released in July, timber and wood products were not directly affected, but the most recent round of tariffs issued by both the U.S. and China specifically included forest products. Given the limited role of export markets relative to total production for most segments of the U.S. timber and forest products sector, we think the overall negative impacts of China’s tariffs on timber values will be minor, but U.S. hardwood producers will be one market segment with a particularly high vulnerability to reduced access to the China market. The U.S hardwood industry has become the world’s largest single source of solid hardwood exports, and China has been the top destination1. In the short time since the imposition of China’s tariff on U.S. wood products, U.S hardwood markets have registered signs of disruption.
Throughout recent months, trade disputes between the U.S. and China have been a key issue for the global economy. The most recent round of tariffs issued by both countries encompasses hundreds of billions worth of goods, including forest products. Effective from September 2018, imported forest-related products from China are levied tariffs ranging from 10% to 25.1 In turn, all forest products exported from the U.S. to China are subject to tariffs ranging from 5% to 25%,2 as a retaliation by the Chinese government. This document details the estimated impacts of escalating trade restrictions on the U.S. forest products industry and interprets the implications on the overall forestry sector.
The strong forward-looking market fundamentals of timberland have attracted strong interest to the asset class. In 2017 timberland transaction activity slowed, possibly signaling a move to reduced competition for properties and more normalized pricing. Timberland markets are not uniform across regions, and a goal of geographical diversification in building a portfolio of properties opens opportunities to capture favorable returns.
The combination of historically high prices for softwood lumber and panels in the U.S. this past summer and the rapid fall in the value of the BRL relative to the USD has boosted Brazilian shipments of softwood panels and softwood lumber to the U.S.
With the real dropping from a January’s 3.2 BRL / USD to July’s 3.8 BRL/USD, Brazil’s exports of softwood lumber and plywood trended higher, reaching a peak in May prior to losing ground in June following the trucker’s strike, and then regaining forward momentum in July.
Brazil’s share of total softwood panel imports into the U.S. increased to 6.4% between January 2018 to July 2018, which was two times greater than the historical average share of 3.2% during the period, 2013(January) to 2017(December). Brazil’s share of softwood panel imports to the U.S. averaged 1.4% for the first seven months of 2018, compared to Brazil’s historical average monthly share of U.S. imports of 0.64% from 2013 (January) – 2017 (December).
Softwood lumber prices in North America have been on a tear over the past 15 months, hitting a record high of $630/MBF this past June, and retreating back 20% to $533/MBF by August1. The extreme volatility in North American wood products markets in 2018 reflects a convergence of factors: shifting U.S. tariffs on softwood lumber imports from Canada; restricted timber supplies in the western U.S. and British Columbia; and rail and ruck shortages across North America. In response to a restricted supply of Canadian lumber for the U.S. market and the elevated prices, softwood lumber production in the U.S. ramped-up, and shipments of non-Canadian softwood lumber to the U.S. increased. The impacts of the large gains in prices and profitability in North America have flowed back to U.S. timber values in an inconsistent manner across regions. U.S. West Coast sawtimber prices nearly matched the strong increases in softwood lumber prices, while pine sawtimber prices in the U.S. South were unresponsive.
Over the past year, U.S. interest rates have moved higher, with the Federal Reserve steadily ratcheting up the Fed Fund rate. More recently, interest rates for longer-term Treasury bonds have also moved higher, responding to stronger domestic and global economic growth and expectations of increasing inflationary pressures. Over the next 18 months, the strong fundamentals currently characterizing the U.S. economy should be sufficient to offset any potential negative impacts of rising interest rates on timberland markets. In the medium-term, timberland should be well positioned to weather a cyclical economic down-turn resulting from further increases in interest rates.
The potential impacts for U.S. timberland owners of the federal tax reform signed into law at the end of 2017 should in general be favorable. The tax reform does curtail some deductions for homeowners (mortgage interest and property taxes), which could provide a headwind for the housing recovery. However, these lost tax incentives will be limited to a particular slice of the income spectrum, and should be largely offset by the favorable positive economic effects of reduced corporate and individual tax rates on overall economic growth. The new legislation left intact provisions of the tax code that specifically support investment in timberland, and the reductions in the U.S. corporate tax rates should encourage increased investment in the U.S. forest product sector, boosting demand for timber from U.S. forests.
U.S. private timberland investment total returns rose to 3.63 percent in 2017, a 103 basis point increase from 2016 with moderate gains in both operating income and capital appreciation. Timberland performance differed across regions. Strong prices paid for logs in the West bumped up cash yields, and expectations for continued strength pushed western capital appreciation up over 300 basis points from 2016. Timberland investments in the South returned below average income in 2017 which resulted in stagnant valuations despite growing capital investment in the South’s forest product sector.
U.S. private timberland investments returned 2.59 percent in 2016, consisting almost entirely of income, as capital appreciation made little contribution. As in prior years, we devote our fourth quarter issue of the Hancock Timberland Investor to a review of investment performance of U.S. private timberland properties. The highest profile measure of timberland property performance in the U.S. is the NCREIF (National Council of Real Estate Investment Fiduciaries) Timberland Property Index, which reports returns for institutional investments throughout the United States.
