Invest in forests, where money really does grow on trees

Returns from timber are uneven, but the tax breaks are great, says David Prosser

Forestry investment has impeccable environmental credentials. Not only is timber one of few renewable raw materials used by industry, but woodlands counter carbon dioxide pollution - and provide a varied habitat for nature. Moreover, forestry investment is tax-free.

"You're making returns through the physical growth of your trees," explains Colin Millais, a director of Forestry Investment Management (FIM).

Millais says that the typical forestry investment currently generates an equivalent annual return of about 4.5 per cent, after costs and inflation. That return consists of two elements. First, over time, the value of woodland appreciates. Second, your forest should produce a crop of timber, which can be sold on the open market.

However, there are no guaranteed returns. Timber prices can be volatile. Also, timber is a long-term venture that does not yield a crop every year. Sitka spruce, the most commonly planted tree in commercial forests, operates on a rotation cycle of 35 to 40 years. Timber is only harvested at the end of each rotation and the forest is then replanted.

Larger forests may include several sections of trees of different ages, which can produce a more regular income stream. Even so, forestry is far from a get-rich-quick investment.

"I wouldn't advise people to invest unless they have spare cash," says Tim Kirk, of Tilhill, another forestry investment company. "Far too many people invest for the tax breaks without giving it enough thought."

The good news, says Catherine Woolley, of forestry investment specialist Fountains, is that the outlook for timber has improved. UK growers can compete with European producers, thanks to the appreciation of the euro against the pound and the rising cost of imports. And, says Woolley, "many UK manufacturers buying timber are looking for wood with UK accreditation."

As a result, UK timber prices rose 5.8 per cent in 2004, according to Investment Property Databank, pushing the total return on forestry to 9.3 per cent for the year. Over the three years to the end of 2004, returns were less impressive, at an annual average gain of 1.9 per cent.

These figures look more attractive when you take into account the tax breaks, however. All income and capital gains on forestry investment are tax-free. You can even roll over capital gains on other investments into a forestry holding and defer the tax that would otherwise be due.

In addition, forestry you have owned for two years or more can be left to your heirs with no inheritance tax to pay on the value. Deferred capital gains tax debts are cancelled if you die before disposing of your forestry investment.

But Colin Gee, of rural surveyor and agent John Gregg, points out that the tax breaks are only available on commercial forestry investments - woodland run as a business - and that investors will need to commit sizeable funds. "Commercial viability would start at about £50,000, though larger plantations costing several hundred thousand pounds are more economic," he says.

The alternative is to subscribe to a collective scheme, where your money is pooled with cash from other buyers. FIM, for example, is raising money for the Timber Growth Fund III. The company will manage the woodland the fund acquires, and investors can acquire forestry exposure with a much smaller investment - the minimum subscription is £10,000.

FIM: 01451 844655, www.fimltd.co.uk; Fountains: 01295 750000, www.fountainsplc.com; John Clegg: 01844 215800, www.john clegg.co.uk; Tilhill: 01786 435000, www.upm-tilhill.com; Woodlands: www.woodlands.co.uk

Harvesting profits

Rural land prices fell 5 per cent during 2005 according to the Royal Institution of Chartered Surveyors. Rics' Julian Sayers says: "Transactions were at a 20-year low because people have been waiting to find out how new rules on European Union subsidies will work, but also every sector of the farming market is facing rising costs and static prices."

Even so, rural land can have potential investment value. "The picture could change very quickly, if people used City bonuses to buy farmland, for example," says Sayers. "Traditionally, farmland has been attractive to people who have accumulated wealth."

Agricultural investments can be structured so that they offer similar tax breaks to forestry - in particular, 100 per cent relief on inheritance tax, and certain capital gains tax advantages, too.

However, while specialists such as Forestry Investment Management do advise on agricultural investments, deals typically begin at £1m. Even collective schemes in this sector require investors to stake £100,000 or more.

"Farms with secure tenants do come on to the market as investment projects," adds Sayer. "Often, buyers bank on the long-term development potential of particular plots within the property."

Steer clear of companies offering plots of land without planning permission. The fact that property investment is not regulated by City watchdogs has encouraged a growing number of "landbankers" to buy up small plots that they sell on to unwary investors, claiming that permission might one day be granted.

"Those who have been suckered into buying these plots are increasingly realising that the chances of planning permission ever being granted are remote," Sayer warns.