CHAPTER TWO

INVESTMENT EQUIVALENTS OF FOREST MANAGEMENT TERMS AND CONSIDERATIONS

Think of Stands as Mutual Funds.

An area of woodland with uniform productive capability and similar tree types and ages is referred to as a stand. Stands can be of any size, but for management purposes and to maintain portfolio diversity, at Tennessee Timber Consultants we believe it is best to keep them relatively small, say at least 10, but less than 50 acres. A large ownership could have several similar, or even identical, stands.

Managed stands of trees bear a close resemblance to “growth and income” mutual funds. As such they have an objective, average rate of return, cost, and relative level of risk. Mutual funds hold shares of company stocks as assets, while the individual assets of a timber stand are trees! Fund managers manipulate stock shares within a portfolio to maximize both "growth" and "income." Likewise, trees in your stands should be sold or retained on the basis of current or potential value performance.

Mutual funds acquire financial growth through supply and demand factors on Wall Street, or wherever, for the stocks held in the portfolio. Stands similarly provide financial growth through supply and demand for trees and the wood products that can be manufactured from them.

In a mutual fund, you purchase or own a defined number of shares, each of which has market value expressed as price ($)/share, or Net Asset Value (NAV). Total ownership in a mutual fund is measured by the number of shares held at the current market price per share. The number of "shares" owned in a stand of trees is referred to as volume and is measured in board feet (most commonly thousand board feet, or MBF), cords, or tons. Timber unit prices are expressed as $/MBF, $/cord or $/ton. The value of a stand is calculated by multiplying the total number of units owned by the unit price. For example, a stand containing 100,000 board feet (100 MBF) of timber valued at $200/MBF has a total value of $20,000.

Income is attained from stocks held in a Mutual Fund through periodic dividend distributions. In like manner trees grow, so each year the number of measurement units you own increases. In other words, your total volume and stand value increases annually. For example, a stand might, through the growth of individual trees, produce an additional 100 board feet per acre each year. Normally, average annual tree growth and resultant volume increases are predictable for any stand of trees.

Think of Trees as Stocks - Picking Winners and Losers

As mentioned above, trees are the individual assets contained in your stands. Just as mutual fund managers attempt to maintain a portfolio of equities that yield a high return, our woodland managers strive to develop stands of high value trees. Portfolio managers retain stocks with high potential (winners), and sell those stocks that have reached the peak of performance or could drop in value (losers). In general, the same philosophy applies to managing trees.

Most trees occurring in Tennessee are sold to local wood using industries which process logs into lumber for domestic markets. Increasingly, however, high value logs are sold internationally with premium prices being paid for American wood exports into Europe and the Pacific Rim. Strategies to produce trees to take advantage of these export markets can be expected to yield high returns for wise, long-term investors.

At appropriate intervals, harvests are conducted to maintain or increase the growth and value of a stand. Over the long term, harvests should be tailored to remove only those trees that have little economic potential (losers), or that are damaging or restricting the growth of the higher value trees (winners) that are identified to be retained.

Ultimately a stand should contain an optimum number of extremely high value individuals. These are then marketed when they have reached their peak performance, and the risk of losing some or all of them outweigh potential further gains.

A Fully Vested Stand

Mutual fund managers often attempt to invest a major portion of cash assets in high quality stocks. That is, they normally try to stay "fully vested." Our woodland managers strive to fully utilize the inherent qualities of the land to maximize the production of high-value wood products. The degree to which a sufficient number of evenly spaced trees are present to fully occupy an acre of land is referred to as stocking.

Under favorable management, most Tennessee woodlands can grow twice as much commercial wood as they are currently producing. Very simply, most Tennessee forests are significantly under-stocked. Innate land and soil conditions predetermine the amount of wood fiber that can be grown on any given acre of land. That wood can be distributed on several small trees, on a few large ones, on the trunks of trees, or in their limbs. Timber harvesting dramatically affects stocking, but traditionally logging is routinely undertaken without any consideration for fully utilizing the productive capabilities of the land over the long term.

A very young stand of seedling-size trees could contain from several hundred to several thousand very small trees depending, in part, upon the kind of trees occupying the site. As the seedlings grow, they begin to compete with one another for sunlight, moisture, and soil nutrients. Eventually, a number of them will begin to die out simply because they cannot compete with their more aggressive neighbors. In undisturbed settings, this "survival of the fittest" process continues throughout the life cycle of a forest.

Our managers identify and quantify those trees with inherently poor competitive characteristics; normally the smallest and poorly formed trees. Rather than simply allowing them to die and fall over, at the earliest possible opportunity, the economic value of these trees is captured by initiating a series of periodic commercial harvests called thinnings. Conducting a proper thinning at exactly the right time in the development of a forest is of great importance, and will profoundly influence financial returns.

Carried out properly, a thinning will leave a very specific number of trees standing in the forest that are spaced at an optimal distance apart. Soil conditions, stand age, average tree size, and the species of trees are some of the specific considerations associated with planning for thinnings. If harvested properly, a thinning will not damage the remaining trees, and will maintain or enhance their growth and health by providing them with necessary growing space. How often thinnings are carried out depends upon many of the before mentioned conditions, coupled with economic strategies or constraints.

Harvesting too few trees in a thinning simply does not achieve the desired outcome of providing optimum growing space for the remaining trees. Maintaining a desired stocking level to optimize tree growth is very important financially, but might also affect the forest's susceptibility to attacks by insects or tree diseases.

Harvesting too many trees during a thinning creates an under-stocked condition that is perpetuated throughout much of, if not the entire life of a stand. In such situations, the growth characteristics of the remaining trees are influenced biologically in many ways, some of which lower their commercial value. Because the trees are spaced too far apart, a common growth response is for trees to develop large, spreading crowns very similar to a tree in your front yard. So, rather than growing valuable wood, trees in under-stocked forests grow limbs. Thinning too many trees, on too often a cycle has caused most Tennessee woodlands to become vastly under-stocked with low value, limby trees. They have value, yes, but a comparatively low value compared with trees grown under optimum conditions.

Mutual fund managers attempt to maintain fully vested portfolios of high value stocks, while our woodland managers establish fully stocked stands of valuable trees. By constantly maintaining a fully stocked stand of trees our managers can put the full productive capacity of your land to work for you.

Divestiture, or Liquidating a Stand

So the question now arises, what happens after a stand has been repeatedly thinned, and all that remains are old, large, high-value trees? Well, it is time to take your highest profit. In other words, it is time to start the process over by harvesting the old trees, while simultaneously investing in creating optimum, sunlit conditions for the establishment of an entirely new forest. Let's call these methods "final harvests."

The most efficient and effective final harvest method is through clearcutting. Clearcutting brings about the end of one generation of trees, and the birth of another. As is the case with most birthings, witnessing the event may not present the viewer with a very pretty picture. But painful and unsightly though it may be, clearcutting provides an optimum environment for the establishment and unimpeded development of young trees either as a result of their natural occurrence from seeds or sprouts, or through planting.

All plants require sunlight, and trees are no different. Without sunlight there can be no trees. Shade cast on the forest floor is plenty adequate to prevent the establishment of desirable new seedlings. A partial harvest of the large trees temporarily provides sufficient sunlight for many seedlings to become naturally established. But, limbs in the crowns of the remaining large trees soon begin to spread out to take advantage of the unexpected new growing space. Sooner or later then, the newly established seedlings become imprisoned under a dense canopy of large, limby trees. When that happens, the sunlight will be cut off, the seedlings simply stop growing, never having the opportunity to develop properly, if they survive at all. Simply put, properly managing trees means properly managing sunlight.

Alternative, less unsightly final harvest methods may be used that approximate the results of clearcutting. These methods aren't actually final, but they are close enough to fit the term. Seed tree, group selection, two-aged, and shelterwood harvest methods come to mind. Apart from the visual benefits of not clearcutting a stand, these methods are sometimes advantageous for some species of wildlife. In addition, they may provide a more attractive setting for potential buyers should you at some point elect to sell your property. The down side of these methods could be that you are leaving your highest value trees at significant risk without any expectation of increasing their worth. Indeed, they will likely lose value, or be lost entirely from environmental influences.

Advanced thought should be given to the affects alternative harvesting methods have on a stand over the short and long term. Three important outcomes must be considered. First, you must create adequate conditions for the replacement of the harvested trees by assuring that a well-stocked stand of desirable trees can become established. Secondly, you must determine what to do with those trees not removed in the first harvest so that the newly established young trees can continue to develop unimpeded. Finally, by applying alternative final harvest methods, you are, in effect, leaving a vastly under-stocked stand of old trees that can rapidly decline in value. Any lost value is the price you would be willing to pay to maintain some degree of visual quality on the harvested area.

The concept of continuously managing stands through a harvesting procedure referred to as "individual tree selection" has been viewed favorably by many woodland owners for many years. The idea being that harvesting individual trees throughout a stand creates adequate conditions for new trees to replace those that were removed. Conceptually then, you would have large and small trees of various ages scattered higgledy/piggledy throughout the stand. This process seems reasonable on the surface, but the fact is, it doesn't work. The actual result is the development of an under-stocked stand of slow growing species of trees well suited for developing in shaded conditions. In fact, the use of individual tree selection, or high-grading, has directly led to the under-stocked, low-value conditions prevalent in our woodlands today.

Properly harvesting a stand of timber throughout its lifetime requires correct timing, but forests are timeless. A forest might be nothing more than small seedlings, but they constitute the first important step in a life cycle that spans decades. Establishing those seedlings in full sunlight and allowing them to develop over the years into high value individuals is one of the vital keys to long-term financial success.

Sustaining long term economic viability requires that you invest energy and money to replace the trees that are harvested. Harvesting cycles that approximate natural events and life cycles will assure that forests can continue to provide economic and environmental benefits for generations to come. As previously mentioned, forests provide us with many things, but they do not provide a free lunch.

Economic versus Biologic Maturity

Did you ever hang around college or professional athletes? Wow, those guys are big! At least on television we've all seen basketball players who are over seven feet tall, and offensive linemen in college and the pro's who are 6'-7" tall, weighing three hundred plus pounds. And, these are all relatively young men. How old will you have to get to be that big? At the opposite end of the spectrum, we also see adult men who never reach five feet in height. Obviously, people grow at different rates, and vary significantly in size at maturity. Genetics and environmental factors affect human growth and development, so you plainly cannot tell how old someone is simply by noting their size.

Just as with people, genetics and environmental factors influence the growth of trees. Even within the same species of trees, young trees are not necessarily small, and very old trees are not necessarily large. As a case in point, you might notice the variation in tree sizes in planted stands of genetically similar pine trees. Keep in mind that all of those trees were planted on the same day with seedlings coming from the same nursery, but you will still see a wide variation in tree heights and diameters. The same thing happens in natural stands of trees except that the variations swing wider because natural genetic variations are more pronounced. So, variations in tree sizes are often more akin to the rate of growth of individuals, as opposed to age.

Environmental factors influencing the growth of people almost always come down to diet. In like manner, since trees need sunlight to produce food (remember photosynthesis?), those individuals with the best opportunity to capture sunlight will grow the fastest. Did you ever notice that trees next to a clearing are larger than their neighbors positioned farther back in the woods? The trees next to the opening are better fed. Beyond any doubt, sunlight is the most important environmental factor affecting the growth of Tennessee’s trees.

Of course environmental factors other than sunlight affect tree growth. Available soil moisture is a prime concern with the establishment and growth of trees. Some species, such as loblolly pine, grow very well with limited soil moisture, where other species, such as oaks, under the same conditions would fair poorly. Available soil nutrients also affect tree growth. In virtually every situation in Tennessee, soil nutrients are sufficient to produce a stand of trees. Fertilization is rarely an absolute requirement, although the application of fertilizers may improve the growth of certain species in specific locations. The cost of fertilization must be carefully weighed against potential added growth. Soil acidity, or soil ph, is another important consideration for many species. Walnut is a very good example of species requiring an alkaline, or fairly high ph soil. Some oak species and loblolly pine perform very well under relatively acidic conditions. These environmental conditions greatly affect how large a tree will be at any point in its life.

You might recall from your early days in grammar school when the teacher discussed how native Americans taught the Pilgrims how to grow corn. Remember the picture of a native American woman bending over to plant a seed followed by a man dropping a fish in the hole for fertilizer? Agricultural specialists took that native variety of “Indian corn,” or maize, and developed genetic hybrids by repeatedly breeding improved varieties of corn in such manner as to capture those traits that maximize production. The benefits from those many years of research have given American farmers the opportunity to dramatically increase profits while feeding our citizens and the world.

When looking at naturally occurring Tennessee hardwood or pine trees, what you are really seeing is the forest's equivalent of that original variety of “Indian corn.” It is exactly what Mother Nature developed, good or bad, coupled with generations of ill-conceived harvesting practices. You often see large, old white oaks with good characteristics, and small white oaks of the exact same age with little added growth or value potential.

Research in tree genetics has been going on for more than 100 years. Scientists are basically doing the same thing with trees that has been done with corn and other agricultural commodities. That is, they look for a tree with desirable traits, and breed it with another tree of the same species with other desirable qualities. Over a long period of time, the goal is to breed fast growing trees with high value potential that can be grown in high capacity nurseries for sale and planting. We already see benefits from that work, most particularly in the growth potential of loblolly and white pine seedlings available from many nurseries. Efforts in hardwood research show similar results for timber production purposes, but only for a very limited variety of species such as cottonwood.

Historically, woodland owners felt that the common sense course for managing their timber was to simply cut the large trees, and leave the small ones to grow. As we have seen, however, this strategy is actually illogical when you consider that cutting only the largest trees most often means harvesting the fastest growers, while leaving small trees usually results in simply leaving the slowest growers. What does that do for the long-term productive capacity of the forest? Guess which trees are left standing to provide seeds to establish future generations of trees? Over the long term, repeatedly cutting the biggest trees while leaving the slow growers standing will create a stand of old, slow growing, low value trees. Actually it's a kind of backwards genetic selection.

So, how big is a mature tree? This question relates to both biological and market influences. A white oak, for example, can possibly live several hundred years, but within only 80 to 100 years it will very probably reach its peak economic value regardless of size. So, while ages of trees and stands is a very important management consideration, of much more vital interest is determining when a tree or stand has attained its highest economic value.

Stand Ages = Total Length of Investment

Investors logically need to know how long it will take to maximize the return from their investments at the final harvest. Foresters refer to the total life cycle of a stand of trees beginning from the establishment of seedlings through the final harvest as one rotation. The number of years it takes for this complete life cycle to occur is further expressed as the length of the rotation.

Rotation lengths vary considerably depending, in part, on the species being grown and land productivity. Other considerations could include integrating wildlife habitat or visual objectives that could shorten or extend stand rotation lengths beyond biologic or economic maturity.

Most native Tennessee hardwoods require long rotations extending from 60 to 100 years. The shorter-term rotations are normally associated with productive bottomlands that are producing softwoods such as gum, cottonwood, or poplar, and very poor uplands that are growing low quality trees. Longer rotations are often needed for the development of high-value trees, such as oaks, on good sites.

Pine rotations aimed at producing sawlogs normally require a medium term investment of 30 to 40 years. Yellow pine pulpwood rotations are normally targeted for shorter terms of 18 to 22 years.

There are few forestry investments with very short rotations. Christmas trees generally require 5 - 8 years before they can be sold, while paulownia rotations require 20 or so years.

It takes a very long time to realize the full economic potential of most forestry investments. However, most woodland owners already have a good start towards attaining high returns through thinnings or final harvests within a reasonable period of time. Considering the long period of time it takes for one rotation to develop, owners must take full advantage of what they already have, and conduct timber harvests only at the right time and only for the right reasons.

Our Foresters are Your Asset Managers

Investors rely heavily upon the expertise of brokerage firms, mutual fund companies, banks, Realtors, and other business professionals to obtain sound advice, management services, or for buying and selling assets. Specialists in stocks, bonds, futures trading and other investments provide a valuable service for a modest fee or commission.

Our professional foresters (foresters with a University degree in Forestry) provide similar services for woodland investors. They are educated and experienced in the science and business of growing and structuring forests to appropriately meet your goals. We can also provide continuing management services, and serve as your broker and agent when timber is sold. Selecting a forester to work with your woodlands is as important as selecting your stockbroker or CPA.

The Tennessee Department of Agriculture, Forestry Division offers professional and technical forestry advice and management planning services. These State provided services are often a good first step towards investigating your woodlands management potential and options. District and Area Foresters are located throughout the State and provide valuable assistance to private woodland owners. To find out which forester covers the county where your land is located, contact:

Tennessee Department of Agriculture

Division of Forestry

Ellington Agricultural Center

Box 40627

Nashville, TN 37204

(615) 360-0720

or their Web Site at http://www.state.tn.us/agriculture/forestry/index.html

Some forest products companies offer professional forestry assistance to private woodland owners through a cooperative forest management program. As a part of the service, however, some companies require a financial commitment from the property owner that is most often in the form of "the right of first refusal" on all timber sales. Cooperative management agreements provide a wonderful service to many landowners, and further information about them can also be obtained from State foresters and Extension Agents

At Tennessee Timber Consultants, our charges for professional services vary, depending in part upon the level of services desired. General advice can often be obtained at no cost to you at all.

Loggers and sawmill operators are very good at harvesting and processing wood products, but very few have an in-depth understanding of forest biology, or can offer sound advice about managing long-term forestry investments. Never rely upon these individuals to provide the management services or expertise you need to maximize returns from your investment.

Some forest products companies employ professional foresters to purchase timber from private woodland owners. Most of these individuals have the expertise to provide excellent advice, but they rarely have the time to conduct a detailed property assessment and prepare long-term recommendations. Remember too, their company's immediate needs and interests will always come first (remember what was said about timber buyers), and you should not expect them to divide their loyalties.

IRA Equivalent

We all understand that investments yielding annual earnings are subject to Federal Income Taxes each year. Depending upon the nature of the investment, these earnings will be treated as ordinary income, or either short term or long-term capital gains.

Individual Retirement Accounts (IRA's) allow you to place a limited amount of money into an interest bearing account each year. Through continued deposits and compounding the interest, over the years the account will gain value. However, Federal Income Taxes are deferred on the interest earned until such time as you reach retirement age and begin withdrawing funds from the account.

In a similar manner, a properly managed woodland will gain value each year, again through growth and income. However, exactly like an IRA, Federal Income Taxes are deferred every year until you receive a profit from the sale of trees. For the income received from sales, most private property owners are eligible to take advantage of long-term capital gains benefits.

Dollar Cost Averaging = Diversifying Stand Ages

Over the long term, maximum income from investing in mutual funds can usually be achieved though dollar cost averaging. That is, regular periodic purchases of additional shares in a fund normally yield higher returns for investors than a one-time purchase. Dollar cost averaging seems to be the better course for investing because shares are purchased when the stock market is high, as well as during downturns.

Simply because you own 200 acres of timber does not mean that you have to harvest all 200 acres at the same time. Harvesting all the timber on a given tract at one time is closely akin to killing the goose that laid the golden egg. More appropriately, wise managers keep their goose healthy and productive by dividing their property into several stands, and periodically reap financial rewards one egg at a time.

Investors should diversify their stands not only throughout the property, but also over time. To the extent possible, they should have several stands of different ages. In much the same way that dollar cost averaging works for mutual fund investments, the greater the diversity in stand ages, generally the higher the returns that will be received over the long term. Where possible, having a variety of age classes of trees allows you the opportunity to take advantage of long-term timber price increases and sustain periodic income.

Managing stands of various ages also provides a major opportunity for mitigating risks. Risk factors such as wildfires, wind and ice storms, insects, and diseases affect trees differently during varying stages of stand development. For example, a young stand of loblolly pine is highly susceptible to wildfire and drought. As the stand ages, though, those factors become less important while the threat from devastating outbreaks of Southern Pine Beetles increases. Therefore, having several pine stands of different ages could help to prevent the loss of your entire pine investment due to one catastrophic event.

Associated benefits resulting from diversifying your woodlands include opportunities for sustaining wildlife, scenic, and real estate values. Generally, the more diverse a forest, the more diverse the species of wildlife that use it. Diversifying stands also allows owners to consider maintaining scenic values because the entire wooded property is not harvested all at one time. Should you be contemplating selling your property at some point in the future, diversifying your woodlands allows you to receive periodic timber income while leaving your options open. Areas of un-harvested timber create added interest for many potential buyers.

It is important to establish a cycle in which different harvest methods and management practices are applied to individual stands at different times. Ideally, you should attempt to develop a definite timeline in which you are harvesting timber at the same rate you can grow it back. This sustainable forest management cycle will ultimately maximize woodland incomes for timberland owners as a result of dollar cost averaging their investments.

Timing the Market.

You may not be able to time events on Wall Street, but you had better be able to time your timber sales. The demand for timber products can change considerably for short or long periods, and it is very important that you sell your timber when market prices are high.

Unlike Wall Street, timber markets rarely move up or down rapidly. Normally, prices change gradually over a period of several weeks or months. Downturns do occur, and sometimes last for a year or more. But, under usual conditions timber does not have to be sold within a short time frame, so during down times owners have the opportunity to simply sit on their investment and wait for market conditions to improve.

Annual cycles also come into play when selling timber. Hardwood veneer markets are usually strongest in the late summer and early fall. Upland stands that can be logged during the winter months normally bring highest prices in the fall and winter. Bottomland tracts that stay too wet to log all winter and throughout much of the spring often bring highest prices during the spring and early summer.

Determining exactly when to sell timber has a profound influence on income and total returns. Again, using a reliable marketing specialist to help make timing decisions is very important.