1. Appraisals and Valuation (Part I)
Before reading this section, please review the Faustmann Model in ECON4 and the NPV and IRR in ECON3.
So far we have learned that forested land is capital that is representative of a store of wealth. It yields a stream of future benefits that are capitalized into the (asset) value of forested land. Here again, we apply the general principles of investment calculations (since an asset's value is the net present value of the benefits it yields). We can also see that investments (forest improvement) can increase the value of a forest asset immediately after an investment. For profitable investments, this increase is greater than the investment cost. Therefore, well-functioning forested land markets serve as an important motive for investments in forest improvement.
A forest valuation (appraisal) is needed for several purposes: (1)Forested properties need to be valued (i.e, book keeping (accounting) and profitability analysis), (2) buyers and sellers need to agree on sales price to determine compensation (3) in government takings for conservation or other public purposes, (4) for inheritance or insurance claims, (5) for property taxation, or (6) to determine collateral on loans.
Several forest appraisal techniques exist to determine market value and the most likely sale price in the market for a forest property. This price will be paid for a forest property, if sold. The emphasis on market value separates the concept of forest appraisal from forest valuation. For example, the soil expectation value based on NPV tells the investor's (maximum) willingness to pay for bare forested land, but does not necessarily reflect the market value.
Appraisal by comparable sales is based on realized prices for comparable forest land sales. In principle, this approach is the best method when data is available. Since markets for forest land are in many countries imperfect and thin; it may be difficult to find a large enough sample for realized prices. For example in Sweden, only 15-20 % of annual transactions of rural properties are "market purchases", and "purchases made by relatives" are about equal and the rest is gift and inheritance (Hultkrantz 1992). In addition, this approach requires quite detailed information on the characteristics of sales (i.e., timber stock).
By learning about timber-related characteristics from realized transactions, it is possible to gather data enabling an estimation of market price models that can then be used for predicting market price for a property with given characteristics.
Appraisal by capitalized income (income method) is based on the net present value (NPV) of a property's most likely future cash flows or revenues and costs (similar to the Faustmann formula). In capitalized income appraisal, we however, seek out the most likely sale price. When applying empirical applications it is important to take into account all the costs (i.e., taxes and transaction costs) that are related to the purchase. The existence of these costs also implies that the value of property has to be higher for the buyer than for the seller. The net present value of forest property is sensitive to management policy: application of Forest Rent and MSY may lead to considerable reductions in forest value (Hyytiäinen & Tahvonen 2003). Stumpage value is what buyers pay for standing timber to be cut immediately (S(T) above). It is unlikely that the market value (based on timber NPV) is current stumpage value.
According to Chang (2001) during the recent largescale privatization of public owned timberlands in New Zealand, Faustmann's formula has clearly demonstrated its worth in establishing the minimum bid price for these lands (New Zealand Institute of Forestry 1999).
By comparing past property sales bid prices and the NPV based on cash flow projections (using different discount rates) it is possible to derive the capitalization rate. The capitalization rate is the discount rate at which the calculated NPV equals the bid price. This logic is similar to that of IRR where IRR is the discount rate at which discounted benefits (NPV) equals discounted costs (initial investment cost and bid price). Hyytiäinen & Tahvonen (2003) found that the average market price for forest estates in southern Finland was low (when compared to the maximized stand value of a representative forest stand using the Faustmann approach). This is possibly reflected by "capital market imperfections, thin markets for forest land, or the fact that the estates sale may consist of younger and less stocked stands than average estates".
Appraisal by replacement cost is based on accumulated (compounded) historical costs. In forestry this method is applicable only to recently planted forests (seedling stands). As an example, we can again use the stand presented in Table E3. We have already calculated the soil expectation value (VF=926 €/ha) which illustrates the (maximum) willingness to pay for bare forest land (year 0 before planting); when used for timber production with expected revenues and costs as defined in Table E3. This net present value follows the principles of appraisal by capitalized income and therefore can be used as an approximation of the market price for bare land.