Forest Finance: Cash-on-Cash Returns, Part I

1 01 2013

Timberland investors naturally care about the cash flows and distributions from timberland investments over time.  These cash flows vary with the products grown, markets served and age distribution of the forest owned.  Also, timberland portfolios can be constructed to meet a range of cash flow objectives.  That said, the use of cash-on-cash returns as a performance metric for timberland investments has narrow applications, if any.

What is cash-on-cash (COCR) return?  It is a measure – a percentage – often used by investors for income-producing real estate.  It is calculated by dividing before-tax cash flow by the amount of cash invested (down payment amount).  If for example before-tax cash flow for an investment property is $15,000 and our invested cash is $100,000, then COCR is 15% ($15K/$100K).

Most reported returns from timberland investments reflect unrealized gains. Timberland indices and appraisals have limitations, complicating efforts to check the status of active timber investments.  This spotlights ways to use hard measures – like cash – to assess performance.   As such, investors new to the timberland asset class often ask about the use of cash-on-cash returns for timberlands, and seek to apply it as a point of comparison.  A meaningful analysis benchmarks cash flows relative to expectations – not just the current year – and relative to comparable investment alternatives.

Part II details limitations of COCR for evaluating timber investments.  In addition, this topic will covered more fully during the February 7th “Applied Forest Finance” course in Atlanta. Click here to register.  The course details necessary skills and common errors associated with the financial and risk analysis of timberland and other forestry-related investments. 

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