This is why I believe farmland is a better asset class than timberland for addition to a portfolio of traditional assets:
- The long term fundamentals of farmland for future land value appreciation are stronger than timberland. The value of timberland is highly correlated with the housing industry, and building materials can be replaced with substitutes in case of high increases in wood prices. However, corn, soybeans or wheat can hardly be replaced and are indispensable. Simply put, farmland produce more of a vital necessity than timberland.
- Farmland owners enjoy more stable cash flow than timberland owners.
- Expected demand growth for primary crops is stronger than for wood due to the rising incomes in the emerging economies that causes a change in people's diet. As income increases, people's diet tend to change as they increase their consumption of protein… As more livestock is needed to satisfy the increasing demand for protein, more feed grain especially corn and soybeans are required.
- The farmland universe is much larger than the timberland universe. It is an untapped market by institutional investors compared to timberland which is already a well represented asset class in institutions' portfolios. ... Since institutional investors are less active in the farmland market, there are likely to be more opportunities to purchase farmland from unsophisticated farmers at discount prices to market value.
- Farmland is less exposed to the risk of fire than timberland.
- Farmland is less sensitive to the general economy than timberland. Eating habits will not drastically change in a recession, however construction activity can completely stop.
... in my opinion the best approach to gain exposure to the farmland asset class is through the purchase of REITs. This also applies for Timberland for the same following reasons:
REITs are able to mitigate the investment risk by being widely diversified.
An internally managed REIT possesses all the advantages of private partnership including professional management, but with less conflicts of interest and no management or incentive fee structure.
It is a liquid and cost efficient way of participating in the returns of a diversified portfolio of farmland or timberland assets with yearly dividend distributions and good long term capital appreciation potential. Shares can be sold anytime, in one click of a mouse, and with only minimal transaction cost.
From a return performance perspective, it could also be argued that REITs have the capacity to achieve higher returns thanks to their access to a wider range of potential deals and a broader access to capital at a lower cost than most individual investor. The historical performance proves this statement as on average REITs have returned 14% yearly from 1975 to 2010.