A Tax Free Commodity Investment

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• TIMBER!
• Money Does Grow On Trees
• What to buy

Whether you paid your taxes early, or you’re still tearing your hair out looking for that one last receipt, there’s something aggravating about April 15^th.

To take your mind off things, I’ve dug up some information on a special kind of tax-free investment: real estate investment trusts, or REITs.

REITs are special companies that pay ZERO corporate taxes as long as they pay out over 90% of their profits to shareholders in the form of dividends. Obviously, you have to pay tax on the dividends – but as a shareholder, that’s the only tax you’ll pay. Non-REIT shareholders get dinged twice: once as an owner (corporate tax) and again as a shareholder (capital gains and dividend taxes).

Okay, I know what you’re thinking: what does a REIT have to do with commodities?

I understand the confusion: many REITs are suffering terribly from collapsing commercial real estate values. Some REITs are nothing more than large-scale landlords for other businesses, so they depend on rents and are responsible for upkeep.

I’d never want to own one of those REITs. But I’m excited about owning another kind: Timber REITs.

These companies are attractive for many reasons. The first and most obvious is the dividend. That’s something you get with any REIT. But there’s further upside for timber companies in general.

Unlike property management REITs that own buildings and are responsible for upkeep, timberland is actually an appreciating asset. They can cut down trees and sell them for cash, or they can leave the trees in the ground to grow in size and value.

On average, timberland increases 6% every year with regular old sun and rain. That’s the kind of safe, non-speculative growth you can count on.

And I expect with lumber selling for higher prices than in previous years that timber REITs will be glad to cut down some trees. We had five years of a bearish market in lumber. Like many things, lumber hit rock bottom back in March of 2009. Now prices are on the upswing.

This chart shows the price in dollars of 1000 board-feet of lumber.

You can see the big drop off in lumber prices back in 2005. That’s when housing construction really started to slow. Most people think that the sub-prime mortgage mess killed housing, but the slow-down actually started back at the end of 2005. In mid-2006, Money magazine ran a story with the headline “Housing Starts Slow: Starts of new homes, building permits both post sharp drops below expectations in latest sign of real estate slowdown.”

There’s still not a lot of bullish news in terms of new housing construction. January jobs data revealed that 40,000 construction jobs got cut. Of course, there is a lot of seasonality in construction and January isn’t a busy month.

But any positive news in construction will be bullish. The thing is: there’s not that many construction jobs left to lose. Many of the 40,000 construction jobs lost were seasonal. It’s tough to build in much of the US in the middle of winter.

When those jobs “come back” this spring and summer, I’ll look for lumber prices to get a further boost. Recent earthquakes in China, Taiwan, Chile and Haiti will buoy prices as well as more lumber will be required to rebuild. And then I expect higher prices will carry through the autumn as hurricane season continues to bolster demand.

The good news is that there are only really two of these companies that look like a buy right now:

Potlatch Corp. (NYSE: PCH) and Plum Creek Timber Co. (NYSE: PCL). Both are American companies, sitting on American timberland. Both should benefit from higher lumber prices – but can literally “grow” in value if prices get too low.

Potlatch pays a 5.4% dividend but they look a little more volatile, and Plum Creek pays a 4.1% dividend and looks to be the safer bet.

If you want to add some exposure to lumber, and collect a modest dividend, look for opportunities to build a position slowly in both companies in dips over the next few months.

Good investing,

Kevin McElroy

Editor

Resource Prospector