August 9, 2022

Are the Original Growth Investments, Agriculture and Timber, Worth It?

Housing and commodities markets can be vexing, but the world will always require what the soil yields.

Reported by Larry Light

Art by Miriam Martincic

People need food and shelter. Those simple propositions have undergirded institutional investments in agriculture and timber for decades. Some asset allocators have soured on them, though, as farmland and timberland are very illiquid, and their returns have been on the low side lately.

Still, this duo—often lumped together because they depend upon biological growth from rich soil—still sports advantages that have long served them well. And that’s over many centuries.

For one, they aren’t correlated to stocks and bonds. Plus, land that grows valuable stuff increases in value. And food and wood tend to have steady returns, although these can be volatile, depending on commodity prices and the housing market.

The two have different growth profiles. Over the decade ending in 2021, investment returns in agriculture averaged 9.6% yearly, while timber returns were lower, at 5.6%, according to the National Council of Real Estate Investment Fiduciaries.

That makes sense. At the century’s start, food commodity prices exploded, then flattened out around 2015, only to surge anew due to the supply disruptions of the pandemic and the Russia-Ukraine war. Investment firm Verus Advisory warns that the higher food prices may be temporary. Some of them have dipped a bit recently (soybeans); some have not (wheat).

Similarly, timber prices started out strong in the aughts amid the housing boom, but the 2008 financial crisis reduced home building, and the wood market has been scrambling ever since.

These are long-term investments, to be sure. Robert “Vince” Smith, CIO of the New Mexico State Investment Council, calls timberland “a terrific investment—the sun comes out and the rain falls,” and thus trees grow.

Smith has less money invested in crops; mainly it’s in cranberries and fruit trees. But he notes that possible food shortages stemming from population increases and the Ukraine conflict should raise “the need for food, and increase profits.”

American farmers are in a good position, he says, as “the U.S. has the best agricultural land in the world.” Indeed, the U.S. is first in corn, beef and poultry; second in soybeans behind Brazil; and fourth in wheat, trailing leader China, India and Russia.

While land appreciation is part of the farm-timber segment’s appeal, the problem is selling off the land in a timely fashion, perhaps to meet a sudden cash need. Sure, real estate overall is never very liquid, but that is doubly the case for farm and timber properties. They are located in far-flung locations outside population centers, where demand for the concentrations of apartment buildings and warehouses maintains a steady turnover.

In a research paper, Thomas Garrett, Verus’ director of strategic research, cautioned: “These asset classes are highly illiquid and in most situations are not suited to tactical investment opportunities. Both timberland and farmland involve long lockup periods, often greater than 10 years.”

That suits a number of institutions, including the Florida State Board of Administration, Utah Retirement Systems and Los Angeles County Employees Retirement Association, which have made investments in such assets.

Let’s zero in on these two investments separately:

Betting the Farm

The long-term outlook for agriculture is positive, strategists say. History demonstrates its track record, although it’s had epic losing spells, too. Over the past 25 years, as of March 2021, farmland has averaged an 11.7% annual return, outpacing that of the S&P 500, per a study from real estate research firm Green Street. Over five years, however, amid the great stock bull market, farm returns shrank to 5.5% annually as commodity prices retreated—and the S&P 500 soared 16.3%.

Only this year have they switched places. The U.S. cropland value averaged $4,420 per acre, including buildings, an increase of $320 (7.8%) from the previous year, a report from the U.S. Department of Agriculture says. The S&P 500, on the other hand, is down 13% in 2022.

Farmland is the rare investment that pairs swelling demand with shrinking supply. Globally, the amount of farm acreage has diminished to 29 billion acres from 30 billion in 2000, said Green Street. Not a lot of farmland comes on the market, around an estimated 2% of the total yearly, as a lot of it is transferred among families.

Traditional real estate assets (office buildings, houses, etc.) deteriorate over time, and need ongoing repairs and renovations to be competitive. Farmland, absent a long drought or some other natural disaster, doesn’t tend to go to ruin if untended. As the Green Street study explains, “improvements in certain crops can be minimal and may require relatively low capital expenditures by the landowner,” such as converting row crops (wheat, corn) into a vineyard.

Farm investing encompasses both revenue from selling crops and on-paper land appreciation. “Farmland income returns have been relatively stable and provided cash flow certainty, including through recessions, while growth prospects from appreciation have contributed to bolster total returns historically,” the Green Street study says.

Over 30 years ending in 2020, 38% of returns stemmed from income and 62% from land appreciation, according to the TIAA Center for Farmland Research at the University of Illinois. The immediate cash income to investors is either some of the crop revenue or rent charged to tenant farmers.

Some 60% of American farms are owner-operated (meaning family farms), and the rest are rented, the USDA’s Census of Agriculture found. A number of large companies are often the landlords, most prominently Gladstone Land and Farmland Properties, which are publicly traded real estate investment trusts.

The world’s woes, of course, affect farms. The Trump administration’s trade war with China harmed commodity prices, ranging from metals to food. The Ukraine war’s curtailment of wheat, which a recent United Nations-backed agreement may be easing, has pumped up prices worldwide.

The war has also crimped the supply of fertilizer, as Russia, Belarus and Ukraine provide large amounts of the ingredients needed (nitrogen, phosphate and potash), Ammar James, a Van Eck analyst and deputy portfolio manager focused on agriculture.

Crops also suffer from water shortages. More broadly, and ominously, climate change could wreck a lot of future crops.

Lumberjacks’ Labor

Timberland’s value has a more muted growth rate than crop-producing acreage, up an average 3.5% over the past five years, to $1,837, woodlands analytics firm Forest2Market’s figures show.

Over time, some 30% of timber’s return comes from selling harvested wood, with 58% from biological growth, meaning the trees have yet to be cut down, and just 8% from land appreciation; the rest is from other sources, such as renting out the land to hunters. Timberland is “less stable” than farms, argues Steve Farrell, co-CIO of Summit Global Investments, because farm rental income is a much larger stream than for woodlands.

This reduced revenue is why the San Bernardino County Employees’ Retirement Association gave up on timber. As a spokeswoman explains, “we’ve had some experience in timber commitments, and it no longer meets our investment philosophy or income-focused strategy.” For what it’s worth, the program doesn’t “have any direct assets in farmland,” either.

The major use of wood products is for housing, which has had a problematic trajectory since the financial crisis. One other use has diminished a lot: paper. Newspapers are no longer ubiquitous, and computer printouts are fewer. On the bright side, wood pulp does have a growth story, amid the popularity of e-commerce deliveries, with their sea of cardboard boxes.

But it may well be that wood has exciting expansion possibilities. Up ahead, wood will increasingly be employed as a renewable substitute for steel, cement and plastics, insists Andy Wiltshire, a managing partner at Folium Capital, which has timber holdings in Latin America.

Beyond that, growing trees is good for the environment, and any number of efforts are afoot to plant more of them. The nonprofit National Forest Foundation is striving to plant or restore one trillion trees by 2030. “Nothing comes even close” to cleaning up the atmosphere of greenhouse gases, Wiltshire says.

For sure, innovation has come to farms and timber. Autonomous tractors, artificial-intelligence-guided herbicide deployment, drone-monitored planting and genetics-developed crops with greater resilience will increase farmlands’ bounty, says Van Eck’s James.

Meanwhile, felling trees no longer requires a Paul Bunyan type with a big ax. Huge machines chop them down and cut them up on site.

Given these possibilities, in time, money indeed might grow on trees in even greater abundance, and on those vast green fields stretching to the horizon.