CORRELATION OF RETURNS

As a background perspective, suppose the correlation of timberland and the Lehman Brothers Corporate Bond Index were +1. This would imply perfect positive correlation, meaning that when Corporate Bonds move up, timberland moves up at exactly the same time. Perfect negative correlation of -1 implies just the opposite. When one asset is up, the other is down. Combining negatively correlated assets is a desirable diversification strategy, and significantly reduces the overall volatility of a portfolio. Diversification can also be achieved by combining assets with zero correlation or low positive correlation.

The actual measured correlation of NCREIF Total Timberland returns with the Lehman Brothers Corporate Bond Index is less than .10, meaning that for the period 1988 to 2004 there was a low correlation between corporate bonds and total timberland returns.

A notable result of the correlation analysis was the negative correlation between commercial real estate, as measured by the NCREIF Property Index, and NCREIF Total Timberland Index.

In general, the reason real estate has not correlated with timberland returns are due to the many fundamental business and economic differences between commercial real estate and timberland.

Although timberland is typically included in the real estate asset class, it is really very different from real estate. Although both use real property, or land, to support income-generating activities, there are very few other shared economic attributes. Where land value for commercial property may comprise a significant percentage of total real property valuations, for timberland the percentage value of land to total property value is about 10 percent. Other differences between “traditional” real estate and timberland include, but are not limited to the following:

• Timberland is a growing asset, and requires moderate to low added capital investment over time relative to asset value.
• Timberland generates income through the harvesting and selling of trees (logs), which are a raw material sold to companies that produce a multitude of wood-based products.
• In a way, timberland is a commodity, not unlike petroleum, which can be “warehoused” indefinitely by simply not harvesting.
• Environmental laws regarding streams, harvest practices, endangered species and other types of laws and regulations change more rapidly relative to commercial real estate.
• Prices for timberland are less volatile than commercial real estate as the economic cycle for timberland, from planting to harvest, is longer.
• Federal government restrictions on harvests from national forests impact the supply of logs available from federal lands. Interpreted as a long-term supply constraint these restrictions resulted in significant price and value increases in private and institutionally owned Northwest timberland in the early 1990’s.
• The sale of logs is the primary business focus for Northwest timberlands, whereas commercial real estate usually supports some other economic or business operations.

The following chart indicates the correlation of the NCREIF Timberland Index to various investment indices. The center vertical line (0.00%) represents the NCREIF Timberland Index. The NCREIF Timberland Index has a low correlation to the various asset classes while it is negatively correlated to both the NCREIF Real Estate Index and the NAREIT. It should be noted that over a longer time period, real estate returns may correlate more closely with timberland.