VARDAMAN VIRTUAL FORESTRY COMPANY

The Most Direct Link to Knowledge Workers in the Southeast Forest Economy

FRACTIONATION: THE KEY TO HIGH RETURNS FROM TIMBERLAND AND TIMBER

In his excellent article "E-Land and E-Timber"
(http://www.vardaman.com/greensheets/new market.htm), Warren Flick described the fractionation of interests in timberland.  Fractional interests such as hunting leases have been around for decades and have usually been successful because they cover only a tiny, well-defined fraction for short periods of time.  Long-term timber leases on large tracts have been much less successful because they extend for decades, provide raw material for the timber company, and are the sole source of income for the landowner.  After a few years, the landowner thinks that the annual payment is too small, whereas the timber company is reluctant to increase it, thereby increasing the cost of its raw material.  Finally, since there is no built-in formula to end the arrangement, a lawsuit follows.

The main reason for the modest income is that large tracts are like mutual funds with stock in thousands of companies.  Although some diversification is desirable, it causes problems when the operations of some companies cannot be monitored and are not well understood by the fund managers.  Large tracts of timberland are enormously variable, and no forest manager in history has ever been or can be an expert on each of the many, many existing situations.  Fractionation other than hunting leases is never considered; the managers, being foresters, are even reluctant to sell portions of it to capture increases in its market value.

The same problems face the owner of almost every tract of more than 40 acres in SE U.S.; you can see why by studying the colored map of AL88121JCS (http://www.se-timbersales.com/tract.asp?TractID=312).  The entire tract contains 240 acres.  JCS, the landowner, rents the yellow areas, to a farmer for row crops, often cotton.  Light green areas are natural stands of 15-20 hardwoods with diverse markets and no growth-and-yield models.  They and the dark green areas are leased for hunting.  The small dark blue area is a lake.

The dark green areas, which were mapped by a GPS survey, are a PPICâ or Pine Plantation Investment Contractâ.  This fractional interest was developed by us and allows us to grow the trees on the area for so many years in exchange for annual cash payments.  Although the contours show that it is not as flat as the row-crop area, growing conditions are relatively similar throughout.  It is a pure stand of 13-year-old loblolly pines, the most-widely used species for the past century and the most-thoroughly researched.  We are not farmers, fishermen, experts on all hardwoods, hunters, or weekend visitors to the cabins, but we do know a lot about loblolly pine plantations.

Neither of us ever heard of fractionation until Warren used the term, but JCS is good at counting money.  By selling the PPIC, he gets an annual cash flow from that area beginning years before the trees can be sold and much larger per acre than he could get from other sources.  If the trees are totally destroyed by fire, windstorm, or insects, his payments will stop, but at least he got the earlier ones, whereas the PPIC owner lost everything.

You can see why JCS would not sell the land under the trees, for he would be left with a patchwork that no one else would want.  Now if he gets an unexpected offer to sell his tract at a big price, he can transfer the PPIC to the buyer or buy it back.  The contract allows him to do so at a cost of the investor’s total outlays plus interest at 10% plus the inflation rate (now 2%) compounded monthly, an annual compound rate of 12.68%.  If the investor had originally insisted on a higher buy-back rate (perhaps 13% or 14%), JCS would have considered the contract to be tantamount to an outright sale and refused to sell it.

PPIC’s are superior to small tracts of timberland because their returns are easy to predict and because environmental restraints are never present.  They are superior to many stocks because the growth of trees is steady and produces no taxable gains except when timber is sold.  They are inferior to both because they have little liquidity and will produce the projected ROI only if held for the proper length of time.

A schedule of estimated cash flows through the PPIC appears on the site with the map.  In operating the PPIC, we have sold the thinning, but since the trees have not been removed, we won’t fertilize it until March 2001.  If a new investor had bought it on 1/1/00, he would have made a down payment of $24,666, agreed to pay $12,100 for fertilizer and $15,798 in annual payments through 2010, and sold the harvest for $452,350 on 12/31/09.  We calculate his ROI under this option to be 13.20%.

If he had made no down payment, increased annual payments to $20,298, paid for the fertilizer, and sold the harvest as above, we calculate his ROI under this option to be 12.85%.

If the investor had paid a lump sum at the outset and then lost all the trees in a windstorm (an insignificant risk but still a possibility), he would have lost it all.  As it is, he would have lost only his cash outlays up to that point.

We offer for sale other PPIC’s in AL, GA, and LA on www.se-timbersales.com.  You can spot them by the unusual ten-digit code names.  An unlimited number of others can be bought for you, but you must give us the details of your investment requirements.  Do you prefer to pay a lump-sum in advance or a series of annual installments?  How much capital do you want to invest?  What minimum ROI do you require?  In what year do you want the harvest (the big pay-off) to occur?  What location do you prefer?  If a PPIC can satisfy your needs, get in touch with us.  If we don’t already have one, it won’t take us long to find one.

Other investors have made offers to buy PPIC’s that cannot be filled by those that we now own.  Most of them want plantations at least ten years old, but others want younger ages.  If you own a plantation and want to follow JCS’s fractionation route to increase your income, get in touch with us.  We’ll reconnoiter it without charge or obligation to you.  We’ll need to know in advance the number of acres, the age, the location, and some idea about the price and payment method that you desire.