Timber REITs grow, harvest trees and convert them to lumber. A typical timber REIT manages millions of private acres, but there are only three main categories of business: timber, wood products, and cellulose. In the timberland segment, the company grows, harvests trees and, at times, manufactures and sells products from what have grown and harvested. The wood products segment includes structural lumber, engineered wood products, structural panels (such as OSB) and softwood plywood, mainly used for residential construction. In the third segment, cellulose fibers are designed for absorbent products, such as diapers.
It is a remarkably innovative industry. Cellulose fibers are not only used in sanitary disposable products; they are also used in printing and writing paper. Wood products, such as structural lumber, are designed for framing residential and commercial real estate. Engineered wood products, such as solid section and I-joists, are used in real estate for flooring, roof joists, headers and beams. And timberland products, such as logs, are made into lumber and building products, and pulp and paper products.
Yet Timber REITs sell a commodity product. Firms compete on price, and then on quality and service. Further downward pressure looms on the prices of timber and lumber because of the Softwood Lumber Agreement expiration on October 2015. Because non-fiber based alternatives are plentiful, an attempt to increase the price of timber results in lower demand.
Substitution to timber is not the only risk. The timber industry is dependent on the homebuilding and credit markets. Residential housing is the most important end-use market for timber. About two thirds of the total US softwood harvest is used by the housing industry. The sensitivity to capital markets relates to home purchase affordability. If home affordability declines due to an increase in interest rates, home demand declines along with the demand for timber.