Can Timberland REITs Spruce Up a Portfolio?

"During the worst of the U.S. downturn, Chinese demand for lumber partially filled the domestic demand vacuum and over the long term, and exports should still represent a larger amount of timber demand than in the previous decade," he explained.

Another potential long-term use for North American timber is cellulosic biofuels (wood pellets) used for power generation and transportation.

Cellulosic biofuels are more attractive politically than first-generation biofuels such as ethanol, because they come from non-food sources and generate fewer emissions.

Large timberlands operators have taken note of the potential upside from biofuel demand. In 2012, Plum Creek (PCL) announced a deal to provide 13 million tons of wood to a European utility provider starting in 2013; Weyerhaeuser (WY) and Chevron are working together on a biofuel joint venture.

(In addition to Plum Creek and Weyerhauser, other RIETS with over a million acres of timberland include Rayonier (RYN) and Potlatch (PCH).)

4.  Positive supply dynamics.

There are positive trends on the supply side. The mountain pine beetle has killed up to 80% of British Columbia's mature pine forest since the mid-1990s and could ultimately reduce total North American supply by 15%.

Dead trees rot and become unusable for lumber and that has forced accelerated harvesting over the past decade.

Artificially high supply has depressed prices for lumber, but the Crofts believe the market is nearing an inflection point as British Columbian harvesting is set to return to more normal levels in the next several years.

This should aid pricing for the U.S. suppliers whose lands have not been affected. 

The Croft Value Fund currently has slightly less than 4% of its assets invested in Weyerhaeuser and Plum Creek. The Crofts stress that they view timberland REITs as a long-term holding and note that there are risks to their projections. These risks include a slowdown in the demand for housing in the U.S. and China, and natural disasters on the timberlands, for example.

To a large extent, though, the Crofts believe market risks are manageable because the timber companies can control the timing of their harvests.

When the housing markets are weak, Kent Croft says, timber managers can let the trees stand. Trees are not like seasonal agricultural products that spoil quickly, so uncut trees continue to grow in value.

"If you don't sell, your assets are growing and increasing in value of use in that a larger tree is used for more things," he said. "So you can choose to harvest later with a more valuable product, if you will, and leave and not sell into a market where prices might not be so good."