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Upward Shot of Forest Trees

Why Timberland REITs Are Riskier Than They Appear

Nov 28, 2020 by Reuben Gregg Brewer
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There are various niches in the real estate investment trust (REIT) sector, but none is more basic than the timberland space. Timberland REITs like industry giant Weyerhaeuser (NYSE: WY) basically just own land with trees growing on them. What could be easier?

But don't be fooled by the apparent simplicity here -- it's important to understand the positives and negatives of the space before jumping aboard. Here's what you need to know.

An easy way to do some good

The obvious thing that makes timberland attractive is the simplicity of the concept. Land with trees: It doesn't take much effort to get that right. Trees kind of take care of themselves, too, meaning no bothersome tenants to deal with. Also alluring is that timber isn't overly correlated with other investments, so it can add valuable diversification to your portfolio.

Right now, there's a huge ESG investing angle to timberland as well. Growing trees capture carbon dioxide. Wood products are easily recyclable. And trees that are cut down (effectively storing the carbon, assuming the wood isn't burned) are typically replaced with new plantings. So investors can do good and make money at the same time with a timber REIT.

There are a number of REIT options to choose from, including $21 billion market cap giant Weyerhaeuser, smaller peers Rayonier (NYSE: RYN) and PotlatchDeltic (NYSE: PCH), and tiny $485 million-market cap CatchMark Timber (NYSE: CTT). Dividend investors will generally approve of the yields in the space, as well, which range between roughly 2% (Weyerhaeuser) to 5.5% (CatchMark). The average REIT, using Vanguard Real Estate Index ETF (NYSE: VNQ) as a proxy, yields around 4.1%, while the S&P 500 Index is yielding less than 2%.

Timber comes with problems

The thing is, running timberland isn't quite as easy as it would seem at first. For starters, all trees aren't alike. Some are good for turning into lumber; others are good for making pulp that gets used to make products ranging from paper to diapers. That's actually a simplified view of things. There's a lot of work and even science that goes into turning trees into useful end products. So it's important to understand what kind of timberland your REIT owns because the key end markets here (lumber and pulp) have different dynamics.

Which also brings up the issue of location. From a big-picture perspective, different types of trees grow better in different regions, but that also means vastly different growing conditions. A drought that leads to wildfires on the West Coast might be little more than a blip for a REIT that primarily owns Southeastern timberland, like Rayonier. But it could be a terrible hit for one more heavily exposed to the Northwestern timber markets, highlighting the fact that running timberland isn't just as simple as letting Mother Nature do her thing. There's actually quite a process involved in managing timber, including planting new trees, overseeing growth, cutting down mature trees, and processing or selling the harvested trees.

There's also other uses for the property that have to be managed, including selling land to developers and granting access, for a price, to companies that want to use the land for other purposes (like renewable power or mineral extraction).

Note that some of the alternate uses of timberland can lead to ESG issues even if the overall picture remains environmentally friendly. Still, at the end of the day, it's the trees that count most. And that's where the biggest issue of all shows up -- wood is a highly cyclical commodity market, and that can lead to dividend cuts.

In fact, over the past decade, three of the four REITs here have cut their dividend at one point. CatchMark is the only REIT that hasn't cut its dividend, but it's worth noting the REIT hasn't increased its dividend since 2016. And, unlike the other names here, it's fairly young, only trading publicly since late 2013. All in, it would be hard to call timber REITs reliable dividend stocks.

Ultimitally, supply and demand determine the prices timber REITs get for the trees they own and, thus, how much money is available for distributions. And it isn't just the U.S. that's important, since trees are often exported to other countries. A big piece of the equation here is construction, which tends to ebb and flow over time. For example, Weyerhaeuser recently noted markets in the West Coast are strong, driven by U.S. construction and overseas construction-led demand from places like China and Japan. However, pulpwood demand is relatively weak, leading to less-desirable pricing for Southeastern production.

That said, Rayonier points out that pulpwood demand differs across the Southeast, and its timberlands are located in relatively strong regions with less supply and more demand. So there's even more complexity here than meets the eye.

The bottom line

Growing trees would seem like a pretty simple business, but that doesn't actually play out when you dig into the details in the timber REIT space. And with the cyclical nature of the sector, dividend investors need to be careful they don't get too attached to the income these REITs generate. If you're looking for an ESG investment with an income component, they might be attractive. However, if what you're seeking is a reliable dividend stream, you might want to look elsewhere in the REIT sector.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Vanguard REIT ETF. The Motley Fool has a disclosure policy.