Affluent investors bet on farms, rail cars amid hunt for yield, income

Ken Slater says he was a novice at growing corn and soybeans when he asked Bank of America Corp.'s U.S. Trust unit to purchase the first of three farms for him in the past two years. A millionaire living in Palm Beach, Florida, Slater was looking for a place to put his money that would provide income, diversify risk and offer capital appreciation. He wasn't thrilled with the returns of corporate and municipal bonds, so he put 5 percent of his portfolio in real assets such as farmland and timber. “To be comfortable with a long-term investment, I have to have some income,” said Slater, a 61-year-old Boston native. “Somebody's going to buy that corn at a price no matter what.” Slater is among a growing number of wealthy individuals who are investing in farms, timberland and funds that finance rail cars in a hunt for holdings that produce income and won't wilt as interest rates rise. An investment traditionally used by endowments, real assets are increasingly being pitched by private banks and wealth managers to affluent families who generally have at least $1 million. The banks point to estimated returns of 5 percent to more than 10 percent, depending on the investment, and offer low-cost loans to leverage gains. Some firms purchase assets directly for clients while others use funds with fees similar to hedge funds and private equity, including a cut of profits as high as 20 percent. Besides the illiquidity risk that usually comes with alternative investments, hazards of owning farms or forestland include summer droughts, floods and wood-eating beetles.

High yields

Unlike a bond, which is very sensitive to interest rates, the return on farmland can be set through a lease to a farmer and go up over time as it's re-priced, said John Taylor, national farm and ranch executive at U.S. Trust. High yields and the desire for an inflation hedge have fueled farmland purchases, Taylor said. Client capital allotted for acreage has tripled since 2010, and U.S. Trust has acquired about $200 million of domestic farmland in the past five years. Treasury yields have surged and bond prices have dropped since May, when the Federal Reserve began signaling it would scale back its stimulus. The central bank may start cutting its asset purchases this year and end them by mid-2014 if the economy meets expectations, Chairman Ben S. Bernanke told reporters in June. Investors have yanked an estimated $109 billion from U.S.- based bond mutual funds since May, according to Investment Company Institute data as of Sept. 4. They've added less than a quarter of that, about $25 billion, to stock funds.

Harvard, Yale

Institutions including pensions and endowments have bought real assets such as farms and timberland for years. Harvard's natural resources portfolio has earned an average annual return of about 13 percent since inception in 1997, according to the university's fiscal 2012 report. Last year the assets gained 2.4 percent. The university sees the asset class as attractive, expecting increasing demand for products such as timber by growing economies, the report said. Yale's endowment had 8.3 percent of its assets in natural resources including timber as of June 30, 2012, and that portfolio produced an annualized return of 16 percent over the past decade, according to the university's report. The bet on real assets including timber and real estate hasn't helped returns every year. In 2009, the asset class was Yale's largest allocation and the investments lost 34 percent, according to the annual report. Yale identified timberland as an attractive investment in the early 1990s, seeing it as a way to diversify, protect against inflation and potentially increase returns.

1980s collapse

Private bankers and wealth advisers are repackaging the professionals' strategy for individual investors. The investments don't suit everyone, even if they can afford the minimums. The assets can be hard to sell quickly and require regular decisions on issues such as equipment upgrades and harvesting. When the agricultural economy sputters, landlords can lose their tenants. Farmland values collapsed in the 1980s, driving down rental income derived from the properties, said David Oppedahl, a business economist at the Federal Reserve Bank of Chicago. Rental revenue fell every year from 1983 through 1987 across the region including Illinois, Indiana, Iowa, Michigan and Wisconsin.

'Dangerously exposed'

Farms returned 7.5 percent in this year's first half, with 5.3 percent appreciation on land and crops plus the income payout, according to the National Council of Real Estate Investment Fiduciaries' farmland index of 547 properties. Average income from the land increased to 1.14 percent in the second quarter, as interest rates began to rise, from 1.02 percent in the prior quarter, NCREIF data show. U.S. farmland may be 15 percent overvalued because of volatile commodity prices, with Iowa acreage potentially 40 percent to 100 percent too steep, according to a June 10 report by London-based Capital Economics Ltd. “Both rents and land values are dangerously exposed to any further decline in corn and wheat prices,” the firm said. Farmland values rose as the price of corn more than doubled in the two years through Aug. 10, 2012, to a record $8.49 a bushel. The most-active contract this year was down 32 percent as of Sept. 11, heading for the biggest annual decline since 1986.

Iowa, Missouri

“You can get a farmer in but he's not going to be able to pay you the rent if suddenly his income has dropped in half,” said Paul Ashworth, the chief U.S. economist at Capital Economics. “At the very least it should make you aware of the volatility.” U.S. Trust, which searches for properties and manages them, found Slater one in Iowa and two in Missouri. The farms, with a combined 4,300 acres (1,740 hectares), ranged in price from $1.5 million to $5 million, Slater said. They're leased back to farmers and hunters, earning him about 5.25 percent each in 2012. Most clients purchase farmland with cash. About 20 percent of them put leverage on a property through loans, Taylor said. Such clients are buying properties with cash to avoid delays with the seller and the leverage is put on later. That can allow them to take advantage of low interest rates to free up capital to buy additional farms or make other investments that are expected to outperform the cost of the loans, he said. The biggest risk is weather, said Christopher Narayanan, the New York-based head of agricultural commodities research at Societe Generale SA. Last year's drought in Great Plains states including South Dakota, Nebraska and Colorado ravaged crops, as did freezing this year in Kansas and Oklahoma.

Forestry squad

Timber, like farmland, is luring high-net-worth clients as an income-producing inflation hedge that doesn't move in step with stocks or bonds, said Don Heath, manager of the natural resources and real estate group at Regions Financial Corp.'s (RF) private wealth-management unit. Regions, based in Birmingham, Alabama, has a team of 17 foresters who locate and manage blocks that are usually 500 to 2,000 acres. “The trick in these hard assets is buying at a reasonable price,” Heath said. Increasing competition in the last couple of years has reduced supply and pushed up prices, he said. “If you buy it right and manage it right, over a long time horizon, you can realize average annualized returns in the five to 10 percent range,” including land and tree appreciation plus sales of harvested wood, Heath said. Timberland gained 9.4 percent in the 12 months ended June 30, the most since the third quarter of 2008, according to the real estate council's index of 442 properties. Cash flows vary depending on when trees are ready for harvest, their size and lumber prices at the time, said Douglas Donnell, national timberland manager at U.S. Trust. Client commitments to the asset class have doubled in 18 months. Slater, the farmland investor, also bought two timber properties through the firm, he said. Paul Young, a 53-year-old engineer and entrepreneur in Wolfeboro, New Hampshire, said he's purchased 600 acres of timberland on his own in recent years to diversify. “It's chugging along and appreciating,” Young said. Costs include property taxes and hiring a forester. A bonus, he said, is the opportunity to walk on your investment and see wildlife including moose, beavers and the big black bear he encountered in June.

Freezing beetles

Insect infestation is a major danger. A beetle explosion has wiped out a quarter of the forests in British Columbia and spread into parts of the Northwest U.S. since the late 1990s, said Jim Girvan, president of MDT Management Decision & Technology Ltd., a Ladysmith, British Columbia-based company in Canada that consults for the forest industry. “The only way you could stop a beetle is to starve it or freeze it,” Girvan said. Potential catastrophe is one reason Windrose Advisors spreads the risk by investing in private funds that manage timber properties, said William Heitin, the firm's partner and chief investment officer. The Boston-based wealth-management firm, which oversees almost $2 billion, has invested in the asset for families since 2009. “As inflation rises the value of real assets goes up --the cost of wood to build a house or to buy plywood or paper,” Heitin said. Families in the funds, which are run by such firms as Atlanta-based Timbervest LLC, commit at least $500,000 for about 10 years and pay 1 percent of assets in fees and 20 percent for performance after an 8 percent return is earned by investors, he said.

Loan funds

Clients have averaged annual returns of 6 percent to 7 percent, according to Heitin. Timber funds gained an annualized 2.2 percent in the three years ended June 30, according to real estate council data. Loan funds are another alternative being offered to affluent investors. Ballentine Partners, based in Waltham, Massachusetts, in March started putting clients into private funds that lend $25 million to $50 million to U.S. businesses. The firm only uses funds that invest in first- or second-lien loans to minimize default risk, said Will Braman, chief investment officer. Families, who must have at least $5 million in available assets, need to commit for as long as seven years and can expect an annual return of as much as 11 percent including interest plus cash from loan-origination fees, Braman said. Managers get fees of about 1.5 percent on assets and 20 percent of profits. The private-bank unit of Wells Fargo & Co. (WFC) has customized alternative-income funds for clients that invest in loans, leases or a mix of both since 2012 and pay out income each quarter, said Adam Taback, president of alternative strategies at the San Francisco-based bank. They've attracted hundreds of millions of dollars, he said. One fund, which acquires and leases out assets such as rail cars, had never distributed income to investors, so Wells Fargo Private Bank asked the manager to create a share class that issues quarterly interest. Investors usually must tie up their capital for two to four years with some strategies requiring as long as a decade, Taback said. Some of the funds have produced 10 percent returns including payouts, he said. Loans are a market where investors need to be “extremely careful” and choose reputable managers, said Todd Petzel, chief investment officer at New York-based Offit Capital, whose clients usually have at least $10 million. “We're seeing all kinds of private-loan funds,” Petzel said. “When you go digging you sometimes discover that these are companies that aren't getting bank financing for good reasons.”