Forest Valuation and Appraisal

The major organization for consulting

foresters who do appraisal work.

Valuation

• Calculating the value an “investor” places on “property”,– NPV– WPL (SEV) of buyer– Reservation price of seller– “Instinctive” value

• Uses of valuations– Offering price– Asking price

Appraisal• Process of estimating “market value”

– Average expected selling price for similar property

– Goal is to obtain the “fair market value”• Def. – Price at which a willing seller and a willing

buyer will trade, neither being under compulsion to trade, and both having access to all knowledge relevant to the transaction

Source of technical literature and training

Appraisal

• Uses– Taxes

• Assessment for property tax levy• Basis of property

– Amount of loan collateral– Estimate damages for insurance or law suites

Stumpage Valuation

• What buyers pay for standing timber ready for harvest– Possible buyers

• Logger• Saw or veneer mill timber buyer• Broker of logs or standing timber

– Broker – buy for resale » accumulate specific products for buyers » broker knows her/his customers

Stumpage Valuation -- from buyer’s perspective

• Stumpage is a residual, or conversion return– Value of veneer or lumber

• Less milling cost• Less overhead for procurement and working capital

– Delivered log price• Less cost of logging and hauling• Less overhead for procurement and working capital, equals

– Stumpage value• Might be called “willingness to pay” for stumpage, WPS

Valuation Factors

• Price of lumber, veneer, or pulp• Efficiency of processing plant• Proximity of stand to mills or brokers’

yards• Price expectations of buyers• Season of the year

Basswood Sawlog Stumpage by Conversion Return Method

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How can a log have a negative conversion return?

Logging and Hauling Cost for Avg. Haul Distance of 53 miles

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Black Cherry Stumpage by Conversion Return Method

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Stumpage Valuation-- from sellers perspective

• Reservation price – Price below which an owner won’t sell

stumpage• Why aren’t conversion return and

reservation price always the same?– Unrealistic perception of timber values– Non-consumptive value given to timber in-situ

Loblolly Pine Pulpwood Forest Values

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Liquidation value

Holding value

Valuation of Large “Tracts” of Timber

• Old growth – no longer relevant• Young timber• Impacts of loans

Young Timber

• Collection of various aged thrifty young growth stands to be cut at different times– Timber’s NPV will likely exceed stumpage

value• Not true if real interest rates are high and buyers

are pessimistic about future stumpage prices

Impact of Loan on Property Valuation

• Leverage – use of existing equity to borrow funds to purchase additional business assets

• Loans are denominated in current dollars– Payments not adjusted for inflation– Loan rate is adjusted by lender for expected

inflation rate and risk• Example – 5% real rate (3% risk-free plus 2% risk),

and inflation rate is expected to be 6%, nominal rate should be (1.05 x 1.06) – 1 = 0.113, or 11.3%

Impact of Loan on Property Valuation

• Example cont. – Borrow $100,000 at 11.3% for 10 years– Annual payment using capital recovery

multiplier100,000 (0.113/(1-1.113-10)) = $17,194.31

Impact of Loan on Property Valuation

• Impact of loan on NPV– Principal enters as a revenue– Payments enter as costs

• Payments are discounted with risk free interest rate since payments are legal obligations

– Continuing with example above, discount rate for loan payments would be (1.03 x 1.06) – 1 = 0.0918, 9.18%

– NPV loan = principal less PV of payments$100,000 – $17,194.31 (1-1.0918-10 / 0.0918)

$100,000 – $109,478.28

-$9,478.28

Impact of Loan on Property Valuation

• If investor had used a higher discount rate, say 14%, the PV of loan would have been $10,312.49

• This would overstate the PV of the loan by $19,790.77, which is – $10,312.49 – (-$9,478.28)

• Result would be overbidding for properties• Impact reduced on after basis because

interest payments usually tax deductible

Appraising Market Value

• Appraisal methods– Comparable sales– Capitalized income– Replacement cost

• Goal of appraisal is estimation of most-likely selling price, not an average price

Appraisal by Comparable Sales• Use depends on availability of sales data

– Data base is a valuable business asset• Factors consider in making comparisons

– Species mix– Quality– Average diameter– Product mix– Terrain– Date of sale– Distance from mills– Road building and logging costs– Log scale used– Type of harvest– Size of sale– Terms of sale – cash at closing, pay-as-cut, installments– Liability for severance or other harvest tax

Adjusting Sales to Make Them Comparable

• Regression analysis– Unit price made a function of sale characteristics– Requires sales data for a relatively short time period

• Or, use trend line as independent variable

– The larger the number of factors (independent variables), the larger the data base required

• Adjustment factors, non-statistical method– Experienced appraisers make adjustments based on

• Knowledge of market, or• Published factors

Appraisal by Capitalized Income

• Referred to as income appraisal or income approach

• It’s simply a NPV calculation, but based on most likely conditions, not the conditions for a specific person

• Used of necessity when no comparable sales are available

• Not useful if non-income benefits are the major output of a property

Appraisal by Capitalized Income --Assumptions

• Use regional average yields• Project prices with trend-lines for real

prices• Proper discount rate to use is difficult to

estimate– Derived capitalization rate – discount rate

used by average buyer in computing price paid for a property• Estimate like IRR for sample properties by

assuming cash flows and finding r that results in observed sales price

Appraisal by Replacement Cost

• Useful if – Trees were planted within the last “few” (less

than 6) years– Land with timber recently purchased

• Assumption is that market price reflects the initial costs, but the further out in time the valuation date is, the less likely it is that past costs affect market price.– Sunk costs don’t matter!!!!

Appraisal by Replacement Cost

• Calculate “Forest NPV”

• Then, compound Forest NPV forward to valuation year, y, and add annual cost,

• This is more like the seller’s asking price based on her costs

Ht + Lt 1-(1+r) -(t-y)

+ (a-c) (1+r)t-y r

Forest NPV (1+r)y + c ((1+r)y -1)/r

Appraisal by Replacement Cost

• Guideline for income approach– When discounting enter incomes as positives

and costs as negatives• Guideline for replacement cost approach

– When compounding historical costs, enter costs as positives and revenues as negatives