VARDAMAN VIRTUAL FORESTRY COMPANY

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HOW MODERN TECHNOLOGY AFFECTS INVESTMENT STRATEGIES

Modern technology developed over the last quarter century by the south's leading scientists (for an example, see long article nearby) should have profound effects on the investment strategies of landowners seeking to make money growing trees. On the other hand, comments that we sometimes hear indicate that some landowners concentrate too intensely on certain aspects of strategy and wind up failing to achieve their major objective. We have described below these comments and the major mistakes caused by following the strategies implied by them.

Before we do this, however, we ask you to review the short section entitled "Internal Rate of Return" in the long article. Please note that the calculation includes not only the trees but also the bare land at its estimated market value. This value ($350 per acre) appears as an investment in Year 0, and its later sale at the same value appears as a cash flow at the end of Year 22. Therefore, the operation earns a compound, annual, real return of 11.67% on all invested capital.

To illustrate our points, we shall use as typical the hypothetical property and the simple method of determining growth discussed under "Growth Study" at pages 98-100 in Jim Vardaman's book "How To Make Money Growing Trees." The timber on this tract grows at a compound, annual, real rate of 7.7%. If this timber has a value of $1,000, its annual growth produces $77.00. But the land is encumbered by it and cannot be used for other purposes, so total investment is $1,000 plus $350 (same as in our example) = $1,350. On this amount $77.00 is a return of only 5.7%. Now on to commonly-held beliefs.

"I don't want to sell timber because my cost basis is zero and I'll have to pay 35% in income taxes." So he contents himself with a return of 5.7%, 35% of which belongs to the government, while running the big risk of price changes and the smaller risks of casualty losses. Now let's suppose that he sells his timber, pays taxes of 35% on gain from it, but no taxes on land because he did not sell it. He now has $1,000 minus 35% = $650 plus $350 in land = $1,000. If he regenerates the tract for $281 (as in our article), his total investment is $350 plus $281 = $631, and it earns a return of 11.67% or $631 times 0.1167 = $73.67. In other words, he has eliminated his obligation to the government, has an annual income almost equal to his present income, and has free cash of $1,000 minus $350 in taxes and $281 in re-investment = $369. Is paying taxes, from which you can usually escape only by dying, really so bad?

"I don't want to sell timber now because Congress may reduce the capital gains tax this session, and I'll have more left." Assuming that the landowner is not holding his breath and that Congress actually changes this rate, he loses each year during the wait only part of the benefits described above.

"I want to sell my timber, but I don't have the money to regenerate my land as you have proposed." If the owner sells her tract, she is out of timberland investment altogether, which may be best for her. But if she keeps it, she still has problems. In the first place, Nature's response to the now-vacant growing space is an explosion of pine and hardwood seedlings, hardwood root sprouts, and herbaceous and woody shrubs of little value. The product of this unregulated competition may be an annual return of less than 3.5% on her $350 timberland investment = $12.25 plus whatever she can earn on the after-tax $650.

The decision is not quite so simple. Regeneration by JMV&CO methods is cheapest immediately after cutting when the tract looks like a bomb hit it; then all the procedures we use are most effective. If Nature's explosion continues for one year, the added growth to be controlled may increase regeneration cost by $25 to $50 per acre, and the improved return has been delayed. The situation gets worse every year. Eventually the tract, for all practical purposes, becomes locked into a management plan that produces a return of 3.5%. At that time its value in a market where investors demand returns of more than 10% has been reduced by two-thirds. Although she may have intended only to postpone her investment, she has actually destroyed about two-thirds of its value (see the Smith family saga in our lead article).

We'll be glad to help you gather the facts needed to analyze and appraise these alternatives. If the math and biology seem complicated, whoever said that making money, in any legal way, is easy?