Risk: What you don’t know can really hurt you

This is the initial article in a series of articles designed to educate forest landowners about some of the basic principles involved in owning and investing in forest land. The motivation to begin this series comes from conversations with forest landowners and investors. I realize that some of the principles may be simple and straightforward, but some principles may be extremely complex and may require more explanation. I would like the topics in this series to be timely, relevant and dynamic, so I would appreciate your feedback. Please send feedback on the articles and suggestions for future articles to rhutchins@agcenter.lsu.edu.

By Robbie Hutchins

Land ownership and private property rights are fundamental American values. The God-given rights of citizens to own land and other private property are so important that our Founding Fathers specifically listed their protection in the Bill of Rights in the United States Constitution. For many people, owning a piece of land, especially a tract of forest land, is the ultimate fulfillment of their American dream.

There are many reasons why one may choose to own forest land. Every landowner has different reasons. In addition, all landowners’ management goals are unique, and their timber and many of their goals are multifaceted. Each landowner is as uniquely diverse as each tract of forest land. However, for the purpose of providing some background information in this article and for this series, I am dividing the various forest landowners into two very, large very inclusive groups.

For the first group of forest landowners, the primary reason they choose to own forest land is for investment purposes. Typically, these landowners have invested in forest land because they view their forest land investment as a hedge against inflation and an opportunity to diversify a portion of their portfolio into assets in which long-term performance is not directly correlated to the performance of the stock market. This group of landowners is composed of private nonindustrial forest landowners, traditional timber companies or one of the two common, regulated entities that own forest land known as real estate investment trusts (REITs) or timber investment management organizations (TIMOs). This type of landowner is primarily concerned with making a profit on an investment through forest management and the associated timber harvests. Even though other nontimber forest resources, such as wildlife, may be important to them, these are secondary to their primary goal of timber production.

For the second group of forest landowners, their primary reason to own forest land is because they want to enjoy nontimber forest resources, such as recreation, water or wildlife. However, these landowners still manage their property for timber production by practicing sound forest management because they understand that good forest management promotes and protects their nontimber forest resources. This group of forest landowners is made up primarily of nonindustrial forest landowners, government agencies, hunting clubs, conservation and preservation organizations, and companies that specialize in outdoor recreation. In all but the most extreme cases, these landowners still want to profit off forest land through periodic timber harvests. These landowners also conduct a wide variety of forest management activities provided that those activities do not negatively affect the nontimber attributes for which they are managing.

No matter which group you may find yourself in, both groups have three things in common. First, just like in any investment, both groups must invest capital to own and manage forest land. Second, just like in any investment, there is a chance that an investment in forest land can be profitable. Third, just like in any investment, there is a chance that all or a portion of the invested capital could be lost, or the investment may be unprofitable. This third point is commonly referred to as risk or business risk.

When asked about risk, Warren Buffett said, “Risk comes from not knowing what you are doing.” From my experience, it seems that only the most educated and sophisticated forest landowners and investors actually understand the types of risks associated with timber and forest land and their potential impacts on their forest land investment. Let’s look at risk and how risk may affect your forest land and your investment.

Business risk can be divided into two broad categories: internal risks and external risks. Internal risks are risks that arise from factors that can be influenced or controlled by the business owner or management. Internal risks cannot be eliminated, but in most cases the effects will be minimized, and the duration of the impacts will be shortened through prior preparation and sound business management. External risks are risks that arise from some variable that is outside the control of the business owner or management. Like internal risks, external risks cannot be eliminated. However, unlike internal risks, it is extremely difficult and sometimes impossible to lessen the effects of external risk by making sound management decisions. About the best one can hope for is that through prior preparation and active management, the duration of any effects resulting from external risks will be shortened. It is very important for forest landowners to understand that both types of risks can result in losses, but sudden catastrophic losses in forest land investment are most often associated with external risks.

This is part one of a series that will continue next in the next issue.

— Robbie Hutchins is an associate area agent specializing in forestry for the AgCenter in the central region of Louisiana.