TIMOs and REITs are facing a production throughput problem that may increase the frequency of land sales and forest fragmentation. The problem is a reduction in profit per acre, regardless of the land's inherent productivity. The average annual net revenue per acre for each of the forest enterprises has decreased as a result of the housing bubble. Stumpage volume sold and unit price have both dropped. Real estate sales previously provided a hedge for volatility in stumpage markets. However, the current real estate market offers little promise of filling the gap through the sale of land for development.
The search is on - what can fill the income gap left from the pruned hedges? This is an important question for the REIT which has a stock price dependent on dividend yields. For the shorter term TIMO landowner, whose anticipated return on investment depended heavily on land appreciation, the dent in annual net revenue translates into a perceived decrease of forest land value.
The figure above is a simple example of the potential impact. For any single organization, the total net profit divided by total acres provides a performance metric: average net operating revenue per acre for the year. The value can be treated as annual rent to the landowner. Dividing the rent by a capitalization rate produces an estimate of average land value today for a series of annual future payments. The x-axis is a range of average acre net revenue. The y-axis is the capitalized value. The lines in the figure represent different capitalization rates.
Assume an investment made in 2000, with expectations of a double digit returns by 2010 when the investor's contract closes. A decrease in net revenue (from $40 to $30 for example) during that ten year period decreases the perceived land value in the eyes of a subsequent buyer. Instead of an overall land appreciation, the $10 per acre drop in revenue translates into a $125 per acre decrease in average land value (at an 8% capitalization rate).
An extended recession and housing slump will cause some investors to allocate their capital to alternatives and exit the timberland market. Those investors remaining will need to develop strategies that find additional sources of revenue. Potential sources include biomass, carbon sequestration, recreation, watershed services, and wildlife habitat management. Collectively, analysts refer to these emerging markets as ecosystem services.
Momentum is building for ecosystem service markets; the recent announcement of a federal Office of Ecosystem Services and Markets is a notable example. News of Spatial Interest will explore these topics in upcoming issues, examining their potential to fill the gap for investors by developing markets on the Edge.