Forestry: where money grows on trees

Forestry has performed well in recent years,enjoying annual returns of 18% over the past decade. But is it a sound investment? Sarah Moore reports.

There's a certain romance to the idea of investing in woodland. You can escape the stresses of modern life and commune with nature in your own personal slice of rural idyll, and make a potentially valuable long-term investment at the same time. However, there's a lot to learn before you decide to dive in.

Most important, you need to decide exactly what you want to get out of the land. There is, as you can imagine, a huge difference between buying an acre of woodland for camping (perhaps with a mind to felling the odd Christmas tree) and buying 15 hectares of commercial forestry. Let's assume that you want your investment to be profitable and not just recreational. Where do you start?

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Forestry as an investment

As with most assets, there are two main ways to make money from trees: capital gains and income. So you can buy a plot of woodland and hope that it goes up in value by the time you come to sell it. Or you can buy a forest and sell the timber that it produces. As an investment, forestry has performed well over recent years. The Investment Property Databank (IPD) UK Annual Forestry index estimates returns on UK forestry by looking at about 120 private-sector forests in Britain. For the ten years to the end of 2015 (the last full year for which data is available), the index experienced annual total returns of 18.4%.

Part of the appeal is that forestry is seen as a good long-term way to diversify portfolios, as it typically has a low correlation to other asset classes (in other words, it doesn't necessarily collapse in value when everything else is collapsing). Also, as Richard Davidson, manager of the Gresham House Forestry Fund, tells The Daily Telegraph: "Compared to some other socially responsible investments, this is an area with low volatility but which is reasonably predictable we know how quickly the trees grow."

Gains have slowed somewhat, coming in at 10.8% in 2015, and last year they slowed further, according to the UK Forest Market Report (compiled by the forestry agents John Clegg & Co and the forestry company Tilhill Forestry). This, naturally, has been blamed partly on uncertainty caused by geopolitical events.

However, the market has "held up well throughout the period". In addition, returns from forestry should increase "off the back of Brexit", says Davidson. Why? Britain imports 70% of the timber it uses, which makes us the world's third-largest net importer of timber, behind China and Japan. But the post-Brexit vote fall in the value of the pound has contributed to making UK timber more competitive than imports.

There are other reasons to expect demand for "local" timber to rise, says John Clegg. Over the past decade there has been "a resurgence in the market for wood used to produce energy" thanks to the boom in biomass boilers and wood burners, incentivised by the government's Renewable Heat Incentive scheme. The government's proposed housebuilding scheme should also boost demand from the construction sector. The market is also expected to tighten and hit a supply shortfall in ten years.

"A fall in commercial plantings during the early 1990s means that the UK is facing a shortfall in timber supply by 2030." This can partly be attributed to the impact of cuts to tax incentives for tree planting that were introduced in 1988. These factors all highlight "the need for proper restocking of harvested crops and additional afforestation if we are to sustain raw material supplies", says Clegg.

The big short-term concern, according to the UK Forest Market Report, is the prospect of another Scottish independence referendum. The "heart of the UK timber-processing industry" is in the Scottish Borders logs, sawn timber and co-products move backwards and forwards across the border on a regular basis. Any "hard border" between England and Scotland could pose "a serious problem".

The tax benefits

So the supply and demand balance looks promising for investors in forestry. Beyond that, another big attraction of the sector is the favourable tax treatment that comes with it. You won't be charged income tax on the harvesting of timber (note, though, that you will still have to pay income tax on money earned by renting out woodland for sporting activities, for example), or have to pay capital gains tax (CGT) on any growth in the value of the trees (although you will have to pay CGT on any increase in the value of the underlying land).

Also, if you use the woodland for commercial purposes, it can qualify for business property relief after two years. That means that there won't be any inheritance tax on it when you die (hence its popularity as a buy-and-hold investment asset). However, be aware that to reap this benefit you will have to demonstrate that the property has been managed as a commercial investment you can't just park a tractor on the edge of the land and be done with it.

According to the industry trade body the Confederation of Forest Industries (Confor), "evidence of commerciality" should include as many as possible of the following: accounts on a yearly basis, a separate bank account in the name of the owner of the business, VAT registration of the business, evidence of active management by a professional forester and evidence that management is conducted "with a view to the realisation of profits", and not just to improve the shooting opportunities or biodiversity of the land.

How to buy

If you're looking to own woodland directly, you can always buy a plot of land. If it's primarily enjoyment you're looking for, then you can buy small areas of "amenity" woodland. For example, theWoodlands.co.uk website currently has 8.75 acres of mainly pine and birch woodlands in East Sussex listed for £59,000. In northern England, smaller plots are available, with four acres in Yorkshire on sale for £36,000, for example. If you are buying as a hobby (and presumably in the hope that the wood's value will grow over time) then bear in mind that you'll need to get public liability insurance (in case anyone is injured while on your land), and you'll also have certain duties when it comes to making sure that trees near footpaths or public roads are maintained and kept safe.

If you are looking to own commercial forestry, it's a different scale of operation (and investment) and it's worth taking specialist advice. Firms such as FIM offer forestry management services. As part of the service, they help with investment selection, land management, marketing and the sale of timber. In return, you will pay FIM an agreed percentage of the net proceeds of timber sales. Direct ownership of forestry, as arranged by FIM, usually involves minimum investments of £3m. In terms of tree type, you will most likely want to invest in spruce. Sitka spruce produces the greatest volume of timber in the shortest time in the UK, with a 35- to 50-year rotation, according to FIM. It also has the greatest diversity of end uses.

Once established, Sitka spruce grows at about 6% a year. These trees are also less vulnerable to pests and diseases than trees with a lifespan of more than 50 years. When it comes to "ideal tree age", younger timberland is more suited to capital growth or for preserving wealth between generations, points out forest management company Scottish Woodlands, while a more mature crop offers shorter-term income from timber sales. In a larger forest, age class will often vary, "offering the prospect of a running yield from timber sales, coupled with capital growth and wealth preservation".

If direct ownership sounds a bit too much like hard work, or you don't have that sort of money to invest in a single, alternative asset class, then you can invest in timber by buying into a fund instead. These tend to be run as unregulated collective investment schemes. This means that they are not covered by the Financial Services Compensation Scheme. So if something goes wrong with your investment, there's not much you can do about it. The two main companies which run forestry investment funds are FIM and Stellar Asset Management.

The minimum investment is high (although still a lot cheaper than buying a commercial forest outright) at £40,000. FIM's funds have an initial charge of 2% and a 0.75% annual management fee, while Stellar's funds have an initial charge of 2% and a 0.5% annual fee. Also, remember that this really is a long-term investment, which means that these funds are fairly illiquid compared with investing in equities. If you need to sell, the fund managers may be able to connect you with an interested buyer, but there's no guarantee you will get the price you want.

You could alternatively invest in the sector via an exchange-traded fund (ETF), such as the London-listed iShares Global Timber & Forestry ETF (LSE: WOOD). Note, though, that this fund only has a 4% exposure to UK timber, so you'll need to be comfortable with investing in overseas timber markets too. Also, it's hardly a pure play on the value of timber or woodland the fund holds 25 of the world's biggest timber-related companies, but that includes companies whose primary purpose is making and selling paper products. The fund has returned 73% over the past five years, pays a dividend yield of 1.7% and the annual fee is 0.65%.