Investing in timberland is a unique opportunity.  Investors with a self-directed IRA or Solo 401(k) who are seeking a means to diversify their holdings might find a place in their portfolio for timber holdings.

Some of the things that make timber investing appealing include solid returns, a hedge against inflation, and relatively low risk and volatility.

Large institutional investors like pension funds and university endowments have invested billions of dollars into millions of acres of forest lands.  Should your self-directed retirement plan follow their example?

Solid Investment Characteristics

Over the last 20 years, returns for timber as an entire asset class have been consistent with those produced by the S&P 500, in the 10-12% range.

Timber is only about half as volatile as equities, however.  According to the National Council of Real Estate Investment Fiduciaries Timberland Index, volatility is close to that of 10-year treasury bonds.

Historical data also shows a positive correlation between timberland returns and inflation.  This makes timber a great hedge against loss of portfolio value during times of inflation.

While positively correlated to inflation, timber tends to be counter-cyclical to financial markets.  This makes timber a great diversification tool.

Demand for timber is global.  As large sections of the developing world in Asia and South America modernize and expand in population, the need for timber is only likely to increase.

An Always Growing Asset

An ounce of gold is always an ounce of gold.

Trees grow.

While the value of a board foot of lumber may change over time, if your IRA’s forest tract continues to add more board feet each year, value is being created.

It can be nice to know even in a market downswing that your investment is experiencing a form of growth.

Multiple Income Paths

Money can be made several ways with timber land investments.

The land itself can appreciate.  The land value for remote properties typically does not increase dramatically.  Properties located in a path of growth or where land use is transitioning can see significant gains, however.  It is possible that the land itself may gain more in value than the income potential of the timber if it can be turned into subdivisions or a golf course.

The value of a forest can increase purely due to market demand for lumber.  During construction booms the cost of softwood timber tends to rise.  Your IRA could sell a property during such a cycle at a profit without needing to wait to harvest the lumber.

Another way a forest property can increase in value is through the maturing of trees.  The additional volume of lumber available is only one way growth has a positive impact.  With many kinds of trees, larger specimens have a higher value because they can be used to produce more marketable finished products.  Small trees are generally only good for pulp and paper products.  Medium trees can be used for small dimension lumber.  Larger trees that can be used to make large sawtimber have the highest value.

In some locations, your IRA may be able to offer hunting leases or generate rental income by some other means.

Your IRA or Solo 401(k) can capitalize on an investment by having the timber harvested or simply by selling the plot to another party after it has increased in value through appreciation and timber growth.

Risk Factors

To be productive, a reasonably sized forest of at least 20 acres is typically required.  Larger parcels will perform better due to the economy of scale they provide.  Since non-recourse loans to purchase timber land are not widely available, the cost of entry can be high.

A long time horizon is required when investing in timber.

Timber land is also fairly illiquid.  Time on market when selling can often range from 6 to 18 months, depending on the location.

Climate and environmental threats merit consideration as well.  Many forests are stressed from drought and insect infestations.

Buying Timber Property

Special expertise is required when considering an investment in timberland.  Unless you happen to be a licensed forester, it is probably best to work with experienced professionals who know both the local land market and timber economy.

The most productive properties will be located near one or more mills that deal in the type of forest product being grown.  A property that will be easier to log in the future will be desirable.  Take care to ensure that the land itself has quality soil and adequate rainfall to be productive.

Of course, the price also needs to be right.  Like most other forms of real estate, you make money when you buy.

Managing Timberland

Just like a backyard garden, a forest needs to be properly tended to produce the best harvest.  Working with a certified forester.  They can help ensure the trees on your retirement plans land reach maximum value through proper thinning, selective harvesting, and attention to insect threats.

Hands-Off Investing is Required

Many investors are drawn to timberland for the non-monetary benefits such holdings provide.  Being able to camp, hunt, fish, or ride horses in your own private forest has a huge emotional appeal.

Unfortunately, when your self-directed IRA or Solo 401(k) owns land, you cannot use that land personally.

The IRS prohibitions against self-dealing also restrict you from acting as forester and actively maintaining or harvesting the timber.

Because there can be no direct or indirect benefit between and IRA and the account holder, we strongly discourage using your IRA to acquire timberland adjacent to any residential property you own personally.

Selling Timber

There are several methods of selling timber.  When investing using an IRA or 401(k) retirement plan, it is important to choose a sales model that would result in capital gains treatment for a non-retirement investor.  Gains will be fully tax-sheltered in these cases, which include:

Outright sale – where the buyer pays a fixed price prior to harvest.

Pay-as-cut – where a unit price is agreed to prior to any cutting.

If the landowner harvests trees and then sells that cut timber to a mill, this is considered earned income.  A IRA that sells on this basis will be subject to tax on Unrelated Business Taxable Income (UBTI).

UBTI will also apply in the case of a percentage sale, where the landowner is paid a percentage of the eventual sale value as determined by a receiving mill after trees have been cut.

A Big Commitment

Timber investing is not for every portfolio, to be sure.  The high cost of entry, long time horizon, and lack of liquidity limit access to those with significant resources and patience.

The relative security, low risk, and quality returns associated with timber investments can be appealing in the right circumstances.

Timber is certainly unique in that you can actually watch your IRA investment grow over time.  (Sorry, couldn’t resist.)