The Discount Rate and Other Factors Affecting Timberland Value

Natural Resource Consultants Since 1921Natural Resource Consultants Since 1921

The Discount Rate and Other Factors That Affect Timberland Value

Roger LordMason, Bruce & Girard

www.MasonBruce.com

Presented atWho Will Own the Forest 7

Sept. 20, 2011Portland, Oregon

http://www.masonbruce.com/

Natural Resource Consultants Since 19212

Questions

• Why have timberland values held up so well compared to other asset classes during “The Great Recession”?

• How do I know if my asset valuation is credible?


Outline

• What drives changes in appraisal values, focusing on key factors affecting Income Approach

• Focus is on western U.S. timberlands, 2008-2011


Westside Timberland Sales

Adjusted for inflation


A Closer Look


Take Away Message

• You can’t reliably draw conclusions about timberland value trends simply by looking at transactions– Too few transactions– Too much variation between properties

So, how have timberland asset values changed?


Approaches to Value

• Appraisers rely on 3 approaches to value– Cost Approach– Sales Comparison Approach– Income Approach


Income Approach

• Discounted Cash Flow analysis– Projected income stream and a reversion

• Key elements:– Timber growth & yield– Projected product prices– Projected harvest volume– Management costs– Discount rate

• Which are most important?


Key Factors Affecting DCF Valuations

• NPV is most sensitive to: – Log price

projections– Discount rate– Near-term

timber yields– Production

costs


Key Factors Affecting DCF Valuations

• Results tend to be similar across different properties within same region

• Sensitivity would vary by region


Log Price Projections

• Log prices depend on end-use demand– Analyze housing starts and other forecasts– Discuss expectations with market participants• When will the housing market recover?• What else will change?

– Unforeseen events• 2010: inventory issues• 2011: log exports


Forecasting & Moving Targets

Recovery to > 1.5 MM units has been 3 to 4 years away… …for the last 4 years.



• At current discount rates, cash flows in the first 5 years represent 15-30% of the NPV– Effect of short-term log market fluctuations are

muted by long-term nature of DCF valuation– Especially because deferred harvest volume can

be stored on stump and will continue to grow


Discount Rate

• Discount Rate Data Sources– Extract from transactions– Market interviews– Cap/Yield rates in other real

estate sectors– Built-up rates– Weighted Cost of Capital

Source: RISI Timberland Market Report


Discount Rate

• Difficult to reliably extract discount rates from transactions– Discount rates & log price projections are linked– High rates coupled with aggressive price scenarios– Low rates more conservative pricing, lower risk


Discount Rate

• Sensitivity to D.R. change varies from property to property

• Depends on profile of income stream over time

• More impact on young forests with back-loaded income stream


Discount Rate

• 4 example properties• Raising rate from 5.0% to

6.25% reduces value by– 13 to 21%– $264 to $881/ac

• Keeping all else constant

PropertyNPV/ac @ 5.0%

NPV/ac @ 6.25%

Delta Delta %

1 4,074$ 3,237$ (837)$ -21%2 4,713$ 3,832$ (881)$ -19%3 2,087$ 1,823$ (264)$ -13%4 4,146$ 3,408$ (737)$ -18%

But “all else” never stays constant!


Observations 2008 - 2011

• Managers have acted to protect value– Deferred harvest– Timed harvests to seasonal market peaks– Pursued export markets• Shifted species mix where possible

– Cut costs to preserve margins• Logging costs down by 15-20%• Haul costs down by 5-10%• Likely to be temporary


Deferred Harvest

• Oregon industry harvest dropped 24% in 2009– 2009 harvest down

33% from 2003-07 average

– Accumulated deferral since 2008 = 70% of previous 5-yr harvest

Oregon Dept. of Forestry data

1.9 BBF


Deferred Harvest

• Washington private harvest dropped more dramatically– 2009 harvest down

47% from 2003-07 average

– Accumulated deferral since 2008 = 101% of previous 5-yr harvest

Washington Dept of Revenue data

2.4 BBF


Timing Harvests

• Managers preserving margins by selling more volume into spring price surges– 2009 caused by supply

chain imbalance– 2010 caused by export

surge

Doug-fir

Whitewoods


Export Markets

-

200

400

600

800

1,000

1,200

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Log Exports: From Columbia-Snake & Seattle Customs Districts (MMBf)

China

South Korea

Japan

Log Export Facilities


Production Cost Management

• Increase bid-based contracting of logging and trucking

• Focus harvests on lower cost tracts

• Reduce road costs• Reduce silviculture and

admin expenses


Take Away Message

• Negative Factors– Increased discount rate– Decreased short to

medium term domestic log prices

– Reduced HBU and auxiliary income

• Positive Factors– Delayed harvest adds

capital appreciation– Timing harvests to

market spikes– Increased export– Reduced logging &

hauling costs– Increased pulpwood

income



Is Your Asset Valuation Accurate?

• What can you look for to judge the quality of your timberland appraisals?


Appraiser Selection

Best Practice• Third-party, independent

general certified appraiser• Qualified and experienced

in timberland asset• Properly supported opinion• Developed with generally

accepted valuation principles and standards

• Appraiser rotation

Watch out for• Over-reliance on internal

valuations (see GIPS & REIS standards)

• Conflicts of interest• Lack of timberland expertise• Lack of geographic expertise


GIPS / REIS

• REIS – Real Estate Information Standards• GIPS – Global Investment Performance Standards– Increasing transparency of real estate industry– Annual external appraisals, unless stipulated

otherwise by client agreement (after 1/1/12)– Externals must be performed by an independent

external professionally designated, certified, or licensed commercial property appraiser

– Recommend appraiser be rotated every 3-5 yrs


Discount Rate

Best Practice• Rate supported by market

evidence– Transactions– Market participant surveys– Other disclosed evidence

Watch out for• Unsupported rate

assumption• Rate not adjusted to

property-specific risk factors



Best Practice• Projections supported by

– Macro-economic analysis– Property-specific history– Reasoned logic

• Log grade or product specific prices

Watch out for• Unsupported price

assumptions• Over-reliance on trend

prices– Long-term price appreciation

not supported by history and/or an economic rationale


Growth & Harvest Projections

Best Practice• Use of property inventory

data • Projected with accepted

growth models calibrated to local conditions

• Correct species mix and log product distributions

• Merchandized to market specifications

Watch out for• Use of regional yield curves

or growth percentages• Initial inventory that doesn’t

match property• Lack of log grades or size

classes (PNW)


Costs

Best Practice• Consideration of property-

specific cost history as well as local market region averages

Watch out for• Unsupported cost

assumptions• Incomplete cost structure


About Mason, Bruce & Girard

• Full service natural resource consulting firm– Forestry Services

• Forest management responsibility on 300,000 acres• Inventory & Biometrics• Planning & Economics• Appraisal & Valuation Services

– Environmental Services– Geospatial Services

• Appraisal & Valuation– Over the last five years, MB&G has appraised 5.0 million acres of

timberland valued at nearly $15 billion– Other valuation services include:

• Acquisition/Divestiture Due diligence• Conservation easements• Litigation Support & Expert Witness

www.MasonBruce.com

http://www.masonbruce.com/


About Mason, Bruce & Girard

David Mason

MB&G began as a forestry consulting business in 1921 under David Mason. Mason began his first forestry consulting firm soon after the 1920 publication of his research on the timber industry and lumber production in the Pacific Northwest.

As a result of his efforts to move the timber industry toward a more professional and sustainable approach to forestry, he became widely known as one of the nation’s first leading advocates of sustained yield forest management.

In 1936, Mason created a partnership with Donald Bruce — Mason & Bruce. Not long thereafter, James Girard joined the group, and in 1948 the firm adopted its present name — Mason, Bruce & Girard.

By the middle of the 20th Century, David Mason’s and MB&G’s influence on the forestry industry was second to none. In fact, in 1952 F.K. Weyerhaeuser said of David Mason: “No single person has been more influential in promoting sound forest management on private forest lands than he.”

Over the years, MB&G has expanded its range of services, and today has diversified into a full-service natural resources consulting firm, with expertise in environmental services, forestry and geographic information systems (GIS).

Documents

The Discount Rate and Other Factors Affecting Timberland Value