Land REITs: Final Inflation Hedges
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REIT Rankings: Timber & Farmland REITs
Publicly-traded landowners – specifically timber and farmland REITs – have been among the best-performing real estate sectors this year amid concerns over persistent inflation and soaring commodities prices. In the Hoya Capital Timber REIT Index, we track the four timber REITs which account for roughly $40 billion in market value and collectively own 16 million acres: Weyerhaeuser (WY), Rayonier (RYN), PotlatchDeltic (PCH), and CatchMark Timber (CTT). We also track the two farmland REITs in the Hoya Capital Farmland REIT Index, which account for roughly $2 billion in market value: Gladstone Land (LAND) and Farmland Partners (FPI).
Consistent with its historical inflation-hedging attributes, timberland values averaged roughly $1,900 per acre in 2021, an increase of 7% from 2020. The Western U.S. – home to higher-valued timber species such as Douglas Fir – has the highest value-per acre at $3,300/acre followed by the U.S. South – home to the relatively cheaper Southern Pine species – at $1,800/acre while the Northern US timberlands are valued at $800/acre. Per the US Dept. of Agriculture, farmland values averaged $3,380/acre for 2021, up $220/acre (7.0%) from 2020. On a per-acre basis, crop and farmland in California is the most valuable at over $10k/acre, followed by the Midwest at $6-8k per acre and the Southeast at $4-5k/acre.
Historically, timberland and farmland have exhibited low correlations to other asset classes and both timber and farmland REITs exhibit some of the lowest levels of interest rate sensitivity within the real estate sector. Investors should note that while timber REITs are quite economically-sensitive due to their high correlation with wood products demand and lumber prices, farmland REITs exhibit limited sensitivity to economic growth expectations, as food demand tends to be far less cyclical. As it relates to inflation-hedging, however, timber REITs reign supreme in the REIT sector, exhibiting one of the strongest upside correlations to inflation expectations, but farmland REITs are close behind.
Amid the ongoing conflict with Russia – which is among the world’s largest exporters of agriculture, gasoline, and timber products – the importance and value of North American production in these key commodities will become especially evident. While the significance of Russian oil and natural gas production has been the key focus of politicians and consumers alike as gasoline prices soared to record-highs, Russia is also the world’s largest exporter of lumber – primarily softwoods – and the seventh-largest exporter of forestry products. Meanwhile, earning its name as the “Breadbasket of Europe,” more than a quarter of the world’s wheat exports, a fifth of corn exports, and nearly 30% of barley exports come from Russia and Ukraine.
Timber Industry Overview & Update
Even before the Russia conflict, commodities prices across essentially all categories were at their highest levels in years amid lingering supply chain issues combined with resurgent demand from the combination of historic levels of fiscal spending and post-pandemic reopenings. Lumber prices, in particular, have been on a wild ride since the start of the pandemic driven primarily by robust demand from the home construction industry. Lumber prices had dipped nearly 70% from their summer 2021 peaks to their lows in late August 2021, but have come surging back over the past five months to back above $1,100/ thousand board feet on indications of resilient demand from homebuilders as the backlog of new home orders continues to swell.
Timber REITs own and/or manage nearly 30 million acres of US timberlands, more land than the smallest five states in the US combined. Notably, Weyerhaeuser and PotlatchDeltic are considered “vertically integrated” timber REITs as they each have significant business operations along the lumber supply chain – not only timberland ownership but also in lumber production and manufacturing – transforming the raw timber into usable construction materials. As a result, these REITs tend to be more sensitive to changes in lumber prices and short-term fluctuations in demand. Rayonier and CatchMark, on the other hand, are more “pure-play” timberland owners and as a result, have seen more muted effects – both on the upside and downside – from volatility in lumber prices.
As discussed in our REIT Earnings Recap, timber REITs reported solid earnings results with PotlatchDeltic and Weyerhaeuser each reporting record-growth across all metrics in 2021. PCH delivered full-year revenue growth of nearly 30%, powering a 71% rise in Adjusted EBITDA and a 153% surge in Earnings Per Share. The company provided solid Q1 guidance and commented that “2022 is off to a great start with the recent surge in lumber prices benefitting both our Timberlands and Wood Products businesses. We expect housing-related fundamentals that drive demand in our business to remain favorable.” Rayonier also reporting solid results with its adjusted EBITDA topping its prior guidance and expects its EBITDA to remain at record levels in 2022 in its initial outlook and guided for EPS growth of 14% in 2022.
Farmland Industry Update
Grains prices have been on a similar upward trajectory, and the Russia/Ukraine conflict came as global wheat and corn stockpiles were already shrinking after a below-average growing season in 2021 and lingering supply chain issues, resulting in significant food price inflation over the prior six months. The Russia conflict has sent prices of corn, wheat, and soybeans higher by more than 20% this year in the U.S. – and at a far faster pace in Europe – which has prompted concerns over food shortages. Even before the full effects of the Russia conflict were felt, global food prices climbed to an all-time high in February, according to the United Nations’ Food and Agriculture Organizationwhile U.S. food prices in February were up 7.9% from last year.
U.S. Farmland is one of the largest commercial real estate sectors valued at roughly $2.5 trillion, comprised of roughly two million farms – 90% of which are considered small family-operated farms. Farmland consists of row crops (e.g., corn) – which is the focus of Farmland Partners – and permanent crops (e.g., fruits) – which is the primary focus of Gladstone Land. Increased demand for food globally has been met with a shrinking supply of available agricultural land, but the productivity of this land has increased substantially, roughly doubling in output every 20 years. Farmland leases generally have a 1-3 year term for row crops and a 5-10 year term for permanent crops, and leases are primarily fixed-rate, but some have a revenue-share component.
Farmland & Timber REIT Performance
Buying land through REITs and other securities has been a “hot trade” over the past year as investors look for ways to hedge inflation. As a result, timber and farmland REITs have been two of the best-performing real estate sectors so far in 2022 with farmland REITs leading the sector with returns of 8.5%. Timber REITs, meanwhile, have delivered returns of -2.1%, still outpacing the -11.3% decline on the Vanguard Real Estate ETF (VNQ) and the -12.2% decline on the S&P 500 ETF (SPY). As noted above, while valuations appear extremely rich for farmland REITs with implied cap rates in the 2-3% range, valuations of higher-quality timber REITs remain quite attractive.
The three large timber REITs each delivered total returns of at least 25% last year while the farmland REITs delivered an especially strong year with Gladstone Land soaring more than 135% – despite AFFO growth that trailed the REIT sector average – while Farmland Partners gained nearly 40% despite recording a decline in its AFFO/share and flat EBITDA growth. Small-cap CatchMark underperformed last year after announcing that it has exited its troubled Triple T joint venture and slashed its dividend. CatchMark initially contributed $200m of the $1.4B total investment to begin the Triple T joint venture alongside other institutional investors in 2018.
Deeper Dive into the Timber Industry
Wood is arguably the most important natural and renewable resource on Earth. A highly versatile and cost-effective material with applications across all industries from paper to fuel, residential construction accounts for the majority – roughly two-thirds – of wood demand. The vast majority of single-family homes in the US are built primarily with wood products, and wood has been increasingly used as a primary structural material in larger multi-family or commercial structures. Wood products account for more than a third of total construction materials cost inputs in the typical single-family home, and the average-sized home requires between 150 and 300 trees to construct.
While they’ve been around for two decades, Timber REITs are still considered a “specialty” REIT sector that straddles the line between the REIT and building materials industries. Real estate ownership is only part of the business for Timber REITs, which take on quite a bit more operational responsibilities than other REIT sectors. There are three primary business lines for timber REITs:
|1) Timberland – The “core” business line. These companies sell timber that is cut and delivered to a production facility by the company itself or through “stumpage,” whereby a third party is responsible for the cutting and transportation. A true commodity, prices of timber are determined by prevailing supply and demand conditions. Usage of timber products for biomass-fueled energy production falls into this category as well.|
|2) Real Estate – These companies lease land to third parties for various uses, including energy production, mining, or recreation, and also market land for sale to homebuilders or other developers. This business line encompasses about 20% of total EBITDA, and Timber REITs have special exemptions under the tax code to qualify as REITs despite operating outside of the traditional definitions of “real estate.”|
|3) Wood Production – To varying degrees, these companies are involved down the supply chain in the production and manufacturing of wood products. Mills transform the raw timber into various wood products, including lumber, OBS, engineered wood, or wood pulp-based products such as paper. Production facilities are generally located in close proximity to timberlands.|
Primarily concentrated in the Pacific Northwest and the Southern US, there are roughly 200 million acres of commercially forested timberlands in the United States. An old forestry maxim is “the forest that pays, stays.” Timber REITs are among the leaders in sustainable foresting, with all four timberland REITs having 100% of their land third-party certified as sustainable either by the Sustainable Forestry Initiative (SFI) or the Forest Stewardship Council (FSC). Due to responsible foresting of privately-owned land and growing demand for wood products (including lumber, paper, and biomass) and despite several years of above-average incidences of wildfires, primarily on federally-owned land on the West Coast, there are actually more trees now than there were 100 years ago, according to the Food and Agriculture Organization.
Timber & Farmland REITs Dividend Yields
Timber REITs pay an average dividend yield of 2.1% while farmland REITs pay an average dividend yield of 1.5%, each below the REIT sector average dividend yield of 3.0% Timber REITs pay out just 35% of their available free cash flow, however, leaving ample capital available for future dividend growth while farmland REITs payout roughly 70% of their normalized FFO.
Record profitability last year has translated into significant dividend growth for PCH and WY. Late in 2021, PotlatchDeltic boosted its regular quarterly dividend by 7.3% and also declared a special cash dividend of $4.00/share, as “the alignment of our lumber-leveraged operating strategy with strong housing fundamentals is generating a record amount of cash.” Last September, Weyerhaeuser announced a $1B stock buyback and a $0.50/share supplemental dividend and paid another special dividend of $1.45/share last month, consistent with its new “base plus variable supplemental” dividend framework. Under this framework, the company expects to supplement its quarterly base cash dividend, with a variable return of cash to achieve a targeted payout ratio of 75-80% of Adjusted Funds Available for Distribution.
As a whole, timber REITs command some of the strongest balance sheets across the REIT sector, an important attribute considering the high degree of economic sensitivity. Weyerhaeuser, the largest Timber REIT, trades on the S&P 500 (SPY), while Rayonier and PotlatchDeltic are included in the S&P 400 (MDY) mid-cap index. Three of the four Timber REITs hold investment-grade long-term bond ratings from S&P. CatchMark Timber and Farmland Partners, each the smallest REIT of their sector, take on a higher degree of leverage. Also of note, Gladstone Land does have two exchange-listed preferred issues, a 5.00% Series D Preferred (LANDM) and a 6.00% Series B Preferred (LANDO), but like the common stock, valuations appear unattractive with yield-to-calls averaging roughly 1% across the two issues.
Takeaways: We Prefer Timber Over Farmland
Publicly-traded landowners – specifically timber and farmland REITs – have been among the best-performing real estate sectors this year amid concerns over persistent inflation and soaring commodities prices. Buying land has been a “hot trade” over the past year, and valuations appear extremely rich for farmland REITs with implied cap rates in the 2-3% range, but valuations of higher-quality timber REITs remain quite attractive. For investors that can tolerate the volatility, timber REIT fundamentals are especially compelling given the record-low housing supply, a substantial backlog of new home orders, and deferred home improvement spending.
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