Forest Finance Q&A: Cash-on-Cash Returns versus IRR and ROI for Timberland Investing

9 01 2013

While cash-on-cash (COCR) return – a percentage often used by investors to evaluate income-producing real estate – has limitations when applied to timberland investment performance, it consistently generates interest from institutional investors.  Below are questions analysts asked us about COCR:

Q:           When estimating internal rate of return (IRR) for a timberland investment since inception based on cash returns, why are timberland portfolios often zero or negative?  How can we recommend such investments?

A:            Timberland investments often have periods of low or negative cash flows, especially when timber prices are low and forest managers delay harvest activities.  In fact, noting that a given tract of timberland has negative cash flows for a given year does not tell us much at all about the quality of the investment.  For example, replanted timberlands generate negative cash flows today and may represent robust and attractive investments.

Calculating negative net IRRs that fail to include an assessment of net asset value (NAV) is like summing cash flows to date and subtracting the purchase price.  This would represent “payback analysis” misapplied.

Q:           What is the difference between return on investment (ROI) and COCR?

A:            Consider the following example:  you acquire a timberland tract for $500,000 and sell it later for $550,000. Your ROI is 10%. The 10% return ($50,000 increase on $500,000 purchase price) reflects the increase in your “total investment (Loan + Down Payment).”  If you put down 50% ($250,000), not accounting for closing costs and commissions, your cash on cash return is 20%. The return you made on invested CASH is 20% ($50,000 increase on $250,000 cash invested).  If you paid all cash for the tract, then COCR and ROI are equal.

Click here to register for “Applied Forest Finance” on February 7th in Atlanta.  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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