Timber investment a hedge for deflation

Timber is the best bet as a hedge during times of deflation, a timber researcher said on Tuesday.

“A misconception we’ve heard more and more of, is that timberland is an inflation hedge… It’s the exact opposite,” said Chip Dillon, a partner at Vertical Research Partners, at the RISI Forest Investment Conference in New York.  He added: “we think that timberland is actually your best deflation hedge.”

According to Dillon, the negative price impact of deflation on lumber prices is more than offset by the tendency of timberland properties to increase in value relative to inflation during low growth period.

As interest rates have gone down since the 1980s, earnings before interest, tax, depreciation and amortisation per acre has remained stagnant in the US at around $40, Dillon said. Meanwhile, land values exploded.

“Timberland is worth roughly five times what it was in 1998, and yet the annual coupon you clip has barely gone up at all,” he said. “It makes sense, in the sense of that 10-year limit with costs of money being so much lower.”

Higher interest rates, on the other hand, have an outsized impact on the cost of home ownership, and therefore, timber returns.

“Income from owning timberland is a function of housing, and housing is a function of interest rates,” he said, offering the example of just a three percent increase in annual inflation. “If you’re in a 15 year amortised mortgage, your payment goes up 20 percent. For a 30 year mortgage, going from a 4 percent to 7 percent interest rate goes up by 40 percent.”

He added demographics are favourable to US housing starts, which he linked to timber returns. A generation of young adults that has been living with their parents, will finally be ready to buy their own homes, and ‘baby boomers’ will be searching for second homes in the next seven to ten years.

“We think there is potential for some explosive demand,” he said. “We don’t think it’s this year. It may not even be in 2017. But we think one of these years we’re going to be surprised [by a jump in US housing starts].”