The New Forest Beasts

I felt it was just a matter of time before the merger phase of the REIT game began

By Dave Skinner

That Weyerhaeuser and Plum Creek are merging might have surprised some Montanans. Not me. Why not? Well, I guess it’s time to remind everyone America’s timber beasts are dead, replaced by a new kind of beast – Real Estate Investment Trusts (REITs).

Now, REITs have been around for a long time, prowling around building shopping malls, skyscrapers, apartment complexes and office parks. Congress created REITs in order to let small investors in on big-time real-estate partnerships.

Sometime in the middle 1990s, Plum Creek (PCL) investor Laura J. Sloate (a brilliant woman, Google her) suggested PCL explore conversion from a Master Limited Partnership into a REIT. REIT’s have one gigantic advantage over “ordinary” corporations, utterly huge. Shareholders in conventional corporations get swatted twice with taxes, with operating profits taxed at 35 percent of net income (minus all the write-offs). Then, shareholders are dinged with another 15 percent capital gains tax.

In contrast, REIT’s must pay 90 percen of untaxed annual profit to shareholders, who are then taxed 15 percent on their capital gain. All things being equal, a dollar in a REIT pays back 35 percent more to an investor than a dollar in an otherwise-identical integrated company. In the Wall Street universe, where billions chase hundredths of a point, that was a big fat hairy deal.

Plum Creek got approval from the Internal Revenue Service to become a REIT in 1999. Overnight, PCL became the 15th largest REIT in America – and triggered a mad copycat rush by the rest of the industry.

Today, no “major” integrated forest-products companies remain in the United States. They’ve all become either REITs, or sold off their land to Timberland Investment Management Organizations, shorthand TIMOs.

Significantly, America’s all-time greatest integrated timber barony, Weyerhaeuser (Weyco for short), held out the longest … in fact, lobbying Congress for tax treatment that would render the company equivalent to a REIT in terms of tax burden and shareholder return. For that effort, in 2008 Weyco scored a reduction in income tax to 17 percent, saving $182 million. Nonetheless, with REITs paying zero – Weyco kept spinning off mills (and people) in order to get under the REIT manufacturing-asset threshold, converting to REIT in 2010.

From then on, I felt it was just a matter of time before the merger phase of the REIT game began.

What matters to us is, REITs and TIMOs aren’t focused on timber, except as a means of generating what stockholders crave – cash. Maximizing cash flow in long-term plays like forested real estate means maximizing Net Present Value, or NPV.

Net Present Value is the worth of tomorrow’s dollar today – cash flows calculated using a “discount rate” that is either a combination of interest and expected inflation, or the rate of return of a competing investment. NPV is a critical business metric that scales up with business size.

To maximize long- and short-term NPV, thereby maximizing cash distributions to shareholders (plus the stock price), Plum Creek management adopted and developed an asset management strategy that breaks the REIT land base into three primary categories,

The first category is “Highest and Best Use,” or HBU. HBU parcels sold for development generate far more cash today than ever and will result over time as timber is grown and harvested. Examples? Whitefish Hills near that city, Bitterroot Lake, Seeley Lake. Sell!

The second category is “core” lands. In terms of ability to generate cash, core is best kept in timber production – for now. They grow well, are within reasonable haul distance from a mill that will buy the wood, yet are too remote from the “amenities” that attract “migrants.” Keep! For now.

The third category, and the one that will matter most to Montana in the coming years, is “non-strategic lands.” These are lands that “don’t fit.” Some non-strategic lands can be perfectly fine “core” to a competitor, of course. But most REIT non-strategic property becomes such because of poor productivity, high political risk, haul distances, management costs – factors causing a low net present value from foreseeable current and future profit opportunity. Dump!

To whom? Well – that’s where it’s about to get really interesting, and I suspect, unpleasant.

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