The pros and cons of forestry investing

Published by Peter Temple on 21 July 2010.
Last updated on 24 August 2011


The UK has good climatic conditions for growing trees, and forestry has grown up as an investment medium over the last few decades as a result of favourable tax breaks, chief among which are tax reliefs that mean that, if the investment is structured in the right way, a forest property represents a good shelter against the depredations of inheritance tax while also producing periodic tax-free income as mature trees are felled and the timber sold. 

None of these tax breaks are guaranteed to remain in place for ever, although they have stood the test of time through successive governments of various political hues. The key element of the inheritance tax concession is that the forest investment must be run as a business and held for more than two years to qualify for the business property relief exemption from IHT. 

It is a well known maxim that a tax break should not 'drive' an investment decision. Forestry can be a good choice as a potential investment, but the decision to investment and the timing of any purchase or sale should not be driven by the incidence of tax relief. 

Put another way, investors can factor tax-free income into calculations of potential returns - assuming the concessions are likely to last - and to work out how an investment would stack up against other alternatives.

But they should not simply put money into forestry for inheritance tax reasons without taking account of whether or not the investment will make money over the longer term. A forestry investment also needs to make sense in the context of the size of an investor's other assets and the size and asset allocation of the rest of their portfolio. 

This is an important point, not least because forest properties can be expensive, and prices have risen sharply in recent years, following a sharp rebound in the price of timber. While smaller woodlands can be had for prices around the £25,000 mark, prices of even medium sized properties can run well into six figures. 

Foresty has also been quite cyclical. From the mid 1990s onwards, forestry prices and timber prices suffered from strength in sterling and a glut of timber from the newly independent Baltic states. It was only from the mid 2000s onwards that prices recovered sharply producing stellar returns for those who had the good fortune to invest at the bottom. 

Forestry returns over the three years to 2008, the latest period that figures are available for, were around 19% on an annualised basis. More sober estimates put the longer term returns from forestry in the region of around 5% in real terms, representing the underlying physical growth in the trees themselves. These are gross returns, however, and would-be investors need to bear in mind that there are costs associated with owning a forest: insurance, management, cost of felling timber, and so on. 

Buying and selling a forest is also much like buying and selling any other property assets; illiquid, time consuming and costly. Agent's costs, stamp duty and the like are reckoned to add around 4-5% to purchase price of a forest property. 

For this reason collective investments in forestry had sprung up over the years, allowing more modest investments to be made without the hassle of direct ownership. 

The idea is that a pool of money is raised from investors and put to work purchasing a range of forest properties. These are managed over the life of the scheme, typically ten years, after which time the scheme is wound up, and the proceeds of the sale of the assets returned to shareholders. 

Schemes like this have quite a few drawbacks, however, the most obvious of which is that ownership is diluted, and you have little or no control over your investment. As a shareholder in a scheme like this, all you own is a share in an unlisted company. The company owns the forest properties. Initial charges are often hefty and the schemes are unregulated. 

Projected returns from schemes like this are not guaranteed and may not be based on realistic assumptions. The other difficulty is with the tax breaks. While income can seemingly roll up inside the scheme tax free, when the scheme is wound up, the proceeds fall within the normal capital gains tax regime as far as the shareholder in a scheme is concerned. Direct ownership is necessary to capture all of the desirable tax benefits.

The verdict:

Forestry is one of those investments that seems to promise a lot, but one in which further inspection throws up a lot of drawbacks. 

In order for a forestry investment not to represent an unduly large part of a portfolio, given the price of even modest properties, a portfolio of other assets well into seven figures is arguably required. 

Using a forest property to shelter an estate from inheritance tax is all very well, but there are other means of doing so, and your heirs may not thank you for leaving them with an illiquid and cyclical investment, whatever the supposed tax benefits. Unlike most investments, there are significant running costs, although if the property is a mature one these can be offset against income from felled timber. 

One new factor helping forest prices in the UK at present is that weakness in sterling makes them more attractive since timber, like many internationally-traded commodities, is priced in US dollars. But investors shouldn't get sucked into investing in forestry for this reason.

A forest is a long-term investment and currency weakness may be a temporary factor. There are other, more liquid, dollar based alternative investments that are simpler and more transparent.

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