Slow Housing Construction Activity and Exports Pull Down Timber REITs

This article is republished with permission from REITCafe.

News of plunging February housing starts in the United States prompts a look at timber real estate investment trusts (REITs). Timber REIT performance is closely tied to timber production and prices, as well as to construction and exports. New housing starts have climbed from their early-2009 trough, but the recovery has been modest, and starts remain significantly below their 2009 peak. Harsh winter weather in early 2015 caused single-family housing starts in February to decline 14.9 percent from January. Illustrating the modest nature of the recovery, February starts were little changed from year-ago levels. Timber REIT investors are also concerned about export volumes and higher interest rates. Together, these factors have pulled down performance. Total returns for 2014 were below average, and timber REIT returns measured –2.4 percent year-to-date through March 18, 2015.

The strength of the dollar has made U.S. timber exports less competitive in an international marketplace. Slower economic growth in China is resulting in less demand for wood and wood products. China has also increased domestic timber production. Total U.S. log exports declined 5 percent, and West Coast log exports declined 13 percent during 2014, according to the U.S. Forest Service’s Pacific Northwest Research Station. China, Japan, and South Korea all are large export markets for U.S. wood products.

Weyerhauser contributed to the timber REIT sector’s weak performance by slightly missing fourth-quarter earnings estimates. With a market cap exceeding $18 billion, Weyerhauser represents about 60 percent of the sector, and its stock price has fallen about 5 percent since year-end 2014. Management believes that the ongoing U.S. housing market recovery and a timber supply shortage from Canada will cause demand for its products to strengthen in 2015, but it does not anticipate a near-term rebound in demand from China or Japan.

The outlook for timber demand is best described as ongoing moderate growth. Further job expansion and low interest rates will lead to modest gains in demand for lumber to build new homes. Homebuilder sentiment has stayed fairly solid in spite of bad winter weather that eroded U.S. homebuilder confidence in February, according to the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) survey. The Western Wood Products Association projects an 8 percent increase in U.S. lumber demand in 2015. Falling timber harvests in British Columbia and Quebec also could push U.S. timber prices higher this year.

Recent building permit activity also indicates modest growth in new construction. February building permits were issued at a seasonally adjusted annualized rate of 1,092,000, which is a 1.7 percent increase above January and a 7.7 percent gain from February 2014.

Longer-term trends for the timber industry are solid. Companies can manage harvests to take advantage of timber prices, while trees that are not harvested grow and become more valuable as time passes. Both exports and timber values have increased over the past five years, especially in the U.S. Northwest, according to Wood Resource Quarterly, and ongoing economic strengthening will cause U.S. demand for lumber to grow further. Nevertheless, the timber REIT sector faces challenges, including the impact of higher interest rates on the economy, homebuying, and REITs.

* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com. ** - 10 yr. Treasury Yield as of 3/19/2015