WHY THE CORRECT RETURN ON TIMBERLAND INVESTMENTS IS 10% ABOVE INFLATION AND HOW TO OBTAIN IT
Owners searching the literature for guidance or asking for advice from foresters
employed by different organizations on how to manage their timberlands properly
run into a vast array of choices. They include: select-cut with natural
re-seeding, clearcut and plant, long rotations for big trees with thinnings
and maybe pruning, short rotations for small trees with no thinning, dense
spacing or wide spacing, herbicides or mechanical site-prep, this species
or that one, controlled burning or not, follow government programs to get
subsidies, maintain "biodiversity" or other buzz words with indefinite meaning,
practice good ecology or stewardship, cultivate beauty, improve habitat
for wildlife of all kinds, or finally keep it untouched for posterity. Advocates
of each method always hint and sometimes claim that it's just a matter of
choice, that one method is as profitable as another. To sort out these claims,
we suggest that landowners recognize that their tracts are actually a form
of capital and then explore what management of capital requires for themselves,
their heirs, society as a whole.
There is no better teacher for this subject than Ludwig von Mises writing
in his famous work "Human Action, A Treatise on Economics" as follows: "At the outset of every step forward on the road to a more plentiful existence
is saving...Saving and the accumulation of capital goods are at the beginning
of every attempt to improve the material conditions of man; they are the
foundation of human civilization. Without saving and capital accumulation
there could not be any striving toward non-material ends.
"Every single performance in the ceaseless pursuit of wealth production
is based upon the saving and preparatory work of earlier generations We
are the lucky heirs of our fathers and forefathers whose saving has accumulated
the capital goods with the aid of which we are working today. We favorite
children of the age of electricity still derive advantage from the original
saving of the primitive fishermen who, in producing the first nets and canoes,
devoted a part of their working time to provision for a remote future...We
are better off than earlier generations because we are equipped with the
capital goods they have accumulated for us."
In a market society like the U. S., the consumer is king, and the pressure
"needed to impel an individual to contribute his share to the cooperative
effort of production is exercised by the price structure of the market.
This pressure is indirect. It puts on each individual's contribution a premium
graduated according to the value of which the consumers attach to his contribution.
In rewarding the individual's effort according to its value, it leaves everybody
the choice between a more or less complete utilization of his own faculties
and abilities...It provides an incentive to everybody to exert his faculties
and abilities to the utmost.
"Ownership of the means of production is not a privilege, but a social liability.
Capitalists and landowners are compelled to employ their property for the
best possible satisfaction of the consumers. If they are slow and inept
in the performance of their duties, they are penalized by losses. If they
do not learn the lesson and do not reform the conduct of their affairs,
they lose their wealth. No investment is safe forever. He who does not use
his property in serving the consumers in the most efficient way is doomed
to failure. There is no room left for people who would like to enjoy their
fortunes in idleness and thoughtlessness."
Although this usually does not happen overnight, many of us have watched
it happen to timberlands owned by a family. Grandfather Smith made a fortune
buying timberlands cheap and merely holding them. Father Smith enjoyed a
good life by selling the growth plus a little bit (so that his capital actually
declined), thinking that Mother Nature would replenish it free of charge.
Granddaughter Smith discovers that, after years of reaping Nature's bounty
with no re-investment in cultivation, annual growth is very modest in proportion
to market value of the lands, so small that she sells them and invests her
capital in more productive media.
Conditions in the general economy indicate how large the return must be
for an investment of this kind to be successful. It is not comparable to
yields on savings accounts, bonds, or stocks; these are very liquid investments
that you can get into and out of in minutes, and the issuers of them have
paid and continue to pay large sums in professional and regulatory fees
each year to maintain their liquidity. The comparable returns are those
earned on "permanent" capital by successful companies. "Permanent" is our
term for capital that must be kept in the company at all times to enable
it to function; it's just as permanent as the capital in timberlands.
When the inflation rate is about 3% as it is now, what return on the market
value of their capital must companies earn "for the best possible satisfaction of the consumers"? The published research on this vital question is huge and has been going
on for decades (we'll suggest a reading list if you ask), but the best answer
came to us direct from Warren Buffett, the most successful investor of modern
times. During the questions and answer session at the annual meeting of
Berkshire Hathaway (BRK) on May 1, Jim Vardaman asked, "What rate do you
charge for use of BRK capital by your wholly-owned subsidiaries?" Mr. Buffett
replied, "14% to 20%" JMV&CO, at the opposite end of the size scale, charges
18% for use of its capital by its managers.
[If these rates seem high to you, don't forget that the capital can't be
removed for other uses without causing the companies to collapse or that
the companies could lose it all. If you are still surprised, maybe you don't
realize how precious capital really is in today's world.]
These rates contain premiums for today's inflation, whereas timber as a
commodity automatically rises in price with inflations. That's why we say
that the annual, compound, real return on successful timberland investments
must be 10%. BRK and JMV&CO want their returns in dollars. You may want
yours in different currency. But if your tract has a market value of $100,000
and it produces only $5,000 each year in dollars plus some wildlife, the
wildlife must be worth $5,000 plus inflation to you, or your investment
will be under increasing pressure from the market economy.
Now back to the choices mentioned in the opening paragraph. We have set
forth in a long article nearby how we can produce the 10+% return in dollars.
It can be done only by applying all modern technology, not cookie-cutter
forestry, and doing so only in harmony with the unique environmental conditions
on your tract. It can be done only by intelligent investments in cultivation
of some kind; otherwise, shrinkage of the return from timber growth is inevitable.
When you want your total return partly in dollars and partly in other benefits,
you should use us to get every penny out of timber sales so that you need
to rely on the other benefits as little as possible.
Finally, to advocates of other management schemes, you should say, "Show
me in detail and with solid scientific backup how I can earn a compound,
annual, real return of 10% by using your system." Don't be surprised if
your answer is either a dead silence or more buzz words.
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