When the coronavirus crisis slammed the U.S. economy, owners of vast forests of timberland saw business take a big hit as most new construction ground to a halt along with demand for wood products.
For the four companies structured as timber real estate investment trusts, returns swiftly bottomed-out, falling 42 percent by mid-March, according to data from Nareit. This was on par with the wipeout seen in the retail, health care and commercial mortgage sectors, though not quite as bad as the 59-percent loss that hit lodging REITs.
What a difference a few months makes.
Timberland real estate is now well into a V-shaped recovery while hotels, malls and office buildings still sit half-empty and retailers shutter stores across the country.
PotlatchDeltic chairman and CEO Michael Covey
“In a very short period, lumber markets shifted from illiquidity to a historic run,” said Michael Covey, president and CEO of timber REIT PotlatchDeltic Corp., during the firm’s July 28 earnings call. After lumber production was curtailed by as much as 40 percent in the early days of the crisis, the price of timber has skyrocketed past the pre-pandemic record, carrying the stock price of those REITs along with it.
So far in the third quarter, timber REITs have posted returns of more than 25 percent, far outpacing even industrial and data center REITs that have held steady for months.
“What really happened is when you saw so much production come out and demand picked up more quickly, nobody had inventory in the channel and it’s just been a scramble ever since,” said Devin Stockfish, president and CEO of timber REIT Weyerhaeuser, on his firm’s July 31 earnings call. They have benefited in part from the rise in DIY home improvement projects. “People have customers that have needs…they’re just out scrambling for product.”
Weyerhaeuser president and CEO Devin W. Stockfish
Those do-it-yourself construction projects — and the booming outdoor dining setups for restaurants— have helped sustain demand for lumber industry wide. “That has just been remarkably strong,” Stockfish said. While the trend came as a surprise, he added: “In retrospect, with everyone being stuck at home, folks not traveling, no sports, nothing else to do, everybody’s doing home remodeling projects.”
Homebuilding has also played a major role. It got off to a strong start to 2020 before the pandemic and has bounced back quickly in recent months, as record-low interest rates continue to boost home sales. Housing starts in July were up 39 percent from a year ago.
“The housing market rebounded sharply in recent months due to the combination of strong demand and the limited supply of both new and existing homes for sale,” said Cris deRitis, deputy chief economist at Moody’s Analytics. He added that following the initial shock in March and April, the real estate industry was able to adapt with virtual showings, electronic signatures and online technology.
“The supply of homes available for sale was already tight before the pandemic struck, which provided some support to housing markets.”
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Without the stabilizing factor of long-term leases that characterize most other real estate businesses, timber REITs tend to find themselves at the mercy of swings in commodities markets — and how long the current rally will last is anyone’s guess.
While timber REIT executives noted that home improvement activity was likely to drop off somewhat after Labor Day, some have expressed optimism that increased home construction would make up for the shortfall.
“There is no sign of a plateauing here,” Potlatchdeltic president and COO Eric Cremers said during the earnings call. “In fact, if you go look at lumber futures on the [Chicago Mercantile Exchange], you see that prices are continuing to rally. So there is no sign of this thing rolling over.”
While deRitis said the housing market is projected to remain strong through the end of the year, he pointed to the foreclosure moratorium for government-backed mortgages as one factor that would limit housing supply. He added that the economic fallout from Covid-19 remains a big risk, but said “job losses have been concentrated in renter households, offsetting some of the impact on demand.” Still, though the near-term impact on single-family home sales will be limited, deRitis said, the longer term impact “is concerning if renting households are unable to find employment and save up for down payments.”
The history of timber REITs began in 1999 with Plum Creek Timber. The timberland owner became the first to take advantage of the corporate tax benefits of the REIT structure. Rayonier followed in 2004, and Potlatch made the switch in 2006. Weyerhaeuser became a REIT in 2010 and would go on to acquire Plum Creek, creating the largest private landowner in the U.S.
With a combined market cap of $28 billion as of July, the four timber REITs represent a small piece of the $1.1 trillion equity REIT universe. Their roughly 20 million acres of land holdings are also just a fraction of the 360 million acres in privately held U.S. timberland. But their publicly traded nature gives investors an opportunity to bet on the timberland sector — which is by and large a bet on the housing market. It’s a market that still primarily uses wooden frames for single-family home construction.
The business models of the four timber REITs differ somewhat, with Weyerhaeuser and PotlatchDeltic owning their own manufacturing businesses that generate significant earnings. Meanwhile, CatchMark has an investment management business and owns much of its land through joint ventures, and Rayonier — after separating from its specialty chemicals division in 2014 — is focused exclusively on its timber business.
Rayonier president and CEO David Nunes
“As a pure-play timberland REIT, we enjoy strong margins and substantially less volatility than downstream manufacturing businesses,” said Rayonier president and CEO Dave Nunes during its Aug. 6 earnings call. And, he added, “we have a geographically diverse portfolio that further mitigates our exposure to any single region or product category.”
In addition to its U.S. holdings, Rayonier also owns 415,000 acres of timberland in New Zealand, which gives it a leg up in the export business with China, a major consumer of lumber products.
Weyerhaeuser also maintains a large export business with Asian markets, though the firm expects to pivot more to domestic sales in the near term thanks to booming prices in the U.S.
“I think China will obviously continue to be a good market for us, but at present we have better pricing opportunities in the domestic market.” Stockfish said. He noted his firm’s system in the Pacific Northwest allows it to “swing volume” between its own mills and domestic and foreign buyers with ease.
China’s post-coronavirus economic reopening — as well as the easing of tariffs as part of the “Phase 1” trade deal between the U.S. and China — are set to boost timber REITs’ China business. U.S. timber, however, still faces competition from Europe and New Zealand in that market.
Like other real estate companies, timber REITs also generate profits from the sale of their properties — often for non-timber uses in what are known as HBU (“higher and best use”) transactions.
“Historically, the sector has had a period where a number of players have sold timberland at timberland value to simply generate cash to fund a dividend that otherwise can’t be funded with normal operations,” Rayonier’s Nunes said. “And we decidedly stepped away from that practice, and really put much more emphasis on premium.”
Another factor that sets timber apart from most real estate is simply biology — timber that isn’t harvested will continue to grow during a price slump, meaning more wood to sell later.
CatchMark president and CEO Brian Davis
“Trees continue to grow, virus or no virus,” CatchMark president and CEO Brian Davis said during his company’s quarterly call earlier this month. “That’s really what’s great about timberland as an investment. Trees have biological growth irrespective of who’s president or what’s happening in the stock market.”
Contact Kevin Sun at ks@therealdeal.com