Assessing Risk: Forestry And Farmland Investment

During the past five years, the global economic meltdown has spurred a spate of reorganizations of the investment portfolios of major institutional investors, many of which are now allocating more capital to real-asset alternative investments in an effort to reduce exposure to volatile financial markets, generate superior investment returns, and underwrite the value of their portfolios with the capital value of niche, income-generating property assets including forestry investments and farmland investment properties that are unlikely to depreciate in the long term.

The logic is sensible, and the likes of Yale University Endowment and their Harvard counterparts have all entered into long-term farmland and forestry investments as part of an overall refocusing of their investment strategy. Historically, land, gold and gems of varying types have been the only store of wealth, it is only since the introduction of fiat currencies that investors have sought to build cash gains, rather than aiming to build a sizable portfolio of land, property or other physical assets. Now, many smaller investors are taking heed of the big boys’ new strategy, and investigating the potential benefits and risks associated with investing in commercial timber properties and agricultural land assets.

Both of these assets classes exhibit characteristics that hold particular appeal during times of economic turmoil. Not only have assets in both sectors outperformed the majority of traditional investment instruments, but also, investment returns are driven by factors and variables that bear little impact from turmoil and volatility in traditional equity markets. Trees continue to grow to valuable timber whatever the economic weather, and increasing demand for resources from China, India and other fast-growing emerging economic drives up the price of sustainably sourced commercial timber and demand outstrips supply.

Capital growth and revenue from farmland assets are also supported by increasing demand. More people simply require more food, and improving diets in emerging market economies require greater inputs of grains, water and other inputs including fertilizers and fuel. All these factors combine to drive up commodity prices (and farm income) on an annual basis, and a lack of suitable land in the face of growing demand also supports long terms capital values.

So, on paper both farmland and forestry investment assets offer a number of advantages to the investors, but there are also a number of asset specific risks that must be acknowledged and understood before venturing into this type of asset as part of a diversified portfolio. Here are some of the headline risks associated with agricultural property investing:

Sectoral Risks

Both farmland and forestry investments display risk-potential that is specific to owning and operating agricultural assets in general. Income is derived from the production and harvest of commodities, be it timber, biomass, energy crops, grains or livestock. Revenues streams can be volatile, with growers subject to prevailing market conditions at the time of harvest. A dip in prices may cause an entire years’ revenue to be wiped out. Energy prices also factor in, especially in relation to farmland. Higher oil and gas prices mean higher farm input prices, further squeezing profit margins.

In the case of forestry investments, value can be stored on the stump during periods of decreased timber demand (and deflated timber prices), as property owners simply leave their trees to grow larger and more valuable until market conditions dictate a sensible time to harvest and sell. There are of course a number of other risk-factors associated with investing in real assets in the agricultural sector, but the major sectoral considerations are volatility and immediate demand for produce.

Location Risks

It is written, and I personally believe, that the vast majority of demand for resources such as energy, timber, food and other commodities will come from fast-growing emerging market economies. China alone exhibits economic growth on such a scale as to dwarf that of developed economies. When 3 billion people drive a car, live in a timber and concrete house, and eat a western diet, then demand for energy and raw materials will reach a level hitherto unseen.

It stands to reason then, that agricultural assets located in regions close enough to, or even inside emerging market economies are best-positioned to participate in the supply chain, and offer enhanced returns for investors due to low asset prices and high demand for end products. Whilst emerging markets offer the best opportunity for superior investment returns, these locations also carry risks not associated with developed nations. The potential for expropriation of land and property by unfriendly governments attempting to win votes poses a very real risk, and investor should carefully investigate the security of title for international investors before committing funds.

Asset Specific Risks

This is where experience and expertise comes in. farms and forests are niche assets and require careful expert management in order to mitigate risk and maximize upside potential. Flood, drought, disease, pests and soil degradation may all affect the income potential (and therefore capital value) of agricultural property assets. Growing commercial timber takes skill, knowledge and experience, and running a successful farm requires the same. My advice? Only ever choose to invest in agriculturally productive properties if you are able to access and retain expert operational partners capable of managing specific assets in the region you wish to invest.

In summary, it could be said that investing in farmland, or timberlands, offers the investor the opportunity to generate non-correlated returns without dramatically altering the overall risk profile of a portfolio. But there are risks, and the risks to be considered are not necessarily the kind of risks that investors are used to acknowledging or assessing. So seek the advice of an experienced consultant with a track record of delivering successful projects, and make sure that you are capable of withstanding long-term illiquidity, as both farmland and forestry investment assets are long-term investments, and investors must consider that they will ride out the bad times along with the good, in the hope to retaining control of some of the world’s most essential, productive assets.

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