Basics of Rate of Return

What does the Rate of Return (ROR) mean?

Rate of return is a measure of how productive an investment is, expressed in percentage terms. For example, if you bought $100 worth of trees and they grew in value to $110 after 1 year then the rate of return would be 10%. The board foot dollar values of logs used to generate the information presented on this site are from the Pennsylvania Woodlands Timber Market Report.

 

What do the ROR calculations assume?

It assumes a price increase that is based only on a 3 % constant inflation rate. If you expect inflation to be higher than 3% then the ROR would be larger than calculated and if you expected the inflation rate to be lower than 3% then the ROR would be lower than calculated. Similar, conclusions would be made if you expected the real price of trees to grow faster or slower than inflation.

 

How should I use the ROR information?

Rate of return information can be used to compare growing trees as an investment with other investment opportunities. Ideally, the investment options should be comparable in length and have similar amounts of risk. As a first approximation, you might compare the 10 year ROR from growing trees to the ROR from a 10 year Certificate of Deposit at your bank.

 

How do differences in risk affect my comparisons?

Higher levels of risk are usually associated with higher expected ROR. For example, if you were comparing two investment opportunities and one was riskier than the other, most people would require a higher expected ROR on the riskier alternative. Growing trees is generally thought to be low risk but not risk free. There is risk associated with weather, wildfire, insects and diseases. This risk depends on the trees being grown and the site - hence you should contact your forester to get a better appreciation of the risk associated with growing your trees.

In order to compare how rate of return changes with tree size, quality, species, and stand treatment go to the next section, Rate of Return and Trees.

 

Trees Generate a Positive Rate of Return

The economic value of trees and forests increases over time as the trees grow. As trees grow larger in diameter and height, their value as a harvested product also increases. Anyone of us who invests money in a business or a mutual fund expects a positive rate of return on our investment. For example, a farm business invests labor, land and money into growing and harvesting crops that will produce a profit when sold. The amount of this profit is measured by the “rate of return” on the initial investment. The greater the profit is, the greater the rate of return.

Examples:

1. A red oak tree that is 10” dbh and has a straight stem is worth $6.97. In ten years, the tree has grown to about 12.5” dbh and the value of that tree has more than doubled to $15.63. The rate of return over that 10-year period is 8.4%.

2. A red oak tree that is 14” dbh and has a straight stem is worth $37.41. In ten years the tree is about 16.5” dbh and the value has tripled to $101.31. The rate of return over that 10-year period is 10.5%.

3. A red oak tree that is 18” dbh and has a straight stem with no branches or other defects it can be considered a veneer tree worth $125.15. In ten years that tree is about 20.5” dbh and the value is $185.66. The yearly rate of return over the 10-year period is 4.02%.

 

The rate of return on a growing tree changes according to on how fast it grows, the quality of the stem and market conditions. The annual rate of return can be compared with other investments of similar risk and duration. Forest landowners should check current timber prices and seek professional advice about the quality of their trees before they harvest. It may be financially advantageous to wait to cut your trees if the rate of return of the growing forest is higher than selling the timber now and investing the profit at a certain interest rate.

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