Wealth from the woodlands
Timberland investment is becoming increasingly popular with institutional investors in both Europe and the US, according to industry participants. Although this growth in interest might end up squeezing profits somewhat, the sector still has many attractive characteristics for pension funds looking for diversification.
By most estimates, timberland investment by both US and non-US institutional investors amounted to about $18bn (€14.2bn) at the end of 2005. The majority of this is accounted for by investment vehicles offered by TIMOs (timberland investment management organisations) based in the US, where most of the forestland is also located.
Outside the US, institutional investors have stakes in holdings in Australia, New Zealand, Canada, Chile and Uruguay, as well as smaller holdings in European forests and in other countries.
Although it is a small asset class, timberland investment has a lot going for it. To start with US timberland has been profitable. The sector has continually offered good and steady returns over a significant time period. According to the NCREIF Timberland Index, US timberland yielded 15.3% nominally on an annualised basis before any asset management fees for the period from 1987 to 2005.
"Compare timberland returns with equity returns," suggests Otto Reventlow, managing director of the International Woodland Company (IWC), a forest investment adviser based in Denmark with $870m under management at the end of 2005. "Forestry seldom if ever shows negative returns, and this is important." In addition, the historically stable returns provide a powerful inflation hedge, he points out.
"Timberland offers strong rates of return when many other asset classes are overvalued," notes Eva Greger, managing partner of the renewable resources group at GMO. GMO has $1.9bn of invested or committed capital, running seven funds. Its low correlation with other asset classes is also a big plus.
The mechanics of timberland investment for institutional investors is simple. Virtually all enter through vehicles offered directly by TIMOs or secondary vehicles packaged by advisers. TIMOs offer REITs (real estate investment trusts) limited partnerships or income trusts.
Although a few institutional investors may own timberland directly, there are definite benefits to going through an intermediary. "It is difficult to invest as a direct owner," says Greger. "Separate accounts would have to invest on a very large scale, because smaller deals are very expensive."
TIMOs undertake intensive research covering a number of areas from the underlying value of the land, the quality and health of the forest, the management and maintenance of the forest, the proximity of processing facilities and the markets for the timber.
Timberland needs careful management to ensure the health of the trees and the productivity of the forest. The TIMO can oversee the forest management. It can also ensure that the forest meets international sustainability standards and has the appropriate conservation certifications; they maintain good relations with NGOs and conservation organisations.
In addition, packaged products from TIMOs include different types of forests in different geographical areas, thus providing a key element of diversification. GMO, for example, owns forestland not only in North America but also in New Zealand, Australia and Uruguay.
A forestry investment has two components. One is the real estate - the actual land on which the trees grow. For this reason, many institutional investors class their forestry investments in their real estate portfolios. Others class it with private equity.
"It is private equity but the valuations have a more tangible basis," says Greger. "The expectation is that the investment will be held in the longer term, for a minimum of 10 years. While it is possible to exit early, it is not easy to find buyers for a mid-term deal."
The other component is the trees themselves. Harvesting them and selling them on for processing can create cash flow in what is otherwise a highly illiquid investment. Timber prices therefore constitute another area of risk but as they tend to rise and fall in line with inflation they also provide a potent inflation hedge. In addition, during falls in timber prices, biological growth is another hedge: there is no need to harvest the trees when prices are not favourable; in fact, more mature trees fetch better prices.
Despite popular apprehensions, there is little actual risk from such factors as disease, insects, fire or other natural disasters. Disease and pests can be easily controlled in well-managed forests, and insurance is available against fire and other natural disasters (often much wood can be salvaged afterward and still put up for sale).
European investors can either work directly with the US TIMOs or they can invest through Europe-based forestry investment advisers, such as the International Woodland Company.
he IWC's Reventlow has been seeing increasing interest in forestry, particularly from investors in northern Europe, from Scandinavia, Germany, Switzerland, Austria and the UK. The company's aim is to help investors build up a diversified timberland portfolio. On the staff are both foresters and economists who work closely with the TIMOs. "We make sure the managers look after the investments our clients have made," said Reventlow.
Most of the timberland investments his clients hold are in North America, because there is a larger scale of private forest holdings there. "In Europe, privately held forests are more scattered and also more expensive," Reventlow explained.
This is not to say that it is impossible to invest in European timberland. Ireland demonstrates the possibilities of local investment. Up until last
year, the Irish Forestry Unit Trust (IFUT) only invested in Irish forestland - its first overseas investment was in Scottish forestland, valued at around €3m, says CEO Brendan Lacey.
But just as the IFUT stayed out of the rest of Europe, at least until very recently, foreign investors have not been much involved in Ireland. "There has been some overseas investment in Ireland, but it's a relatively small market," Lacey says. "The level they would want would swamp what we have available here."
IFUT started in 1994 with about €3m, and now it amounts to €150m. For tax reasons, it is only open to Irish pension funds and other tax-exempt institutional investors.
Much of the Irish forestland is new forest, as farmers have been encouraged by government and EU initiatives to diversify the planting and include timberland areas on their land to increase Irish forest cover.
Lacey says that he is now looking at setting up a subfund that will focus on international forestry investment. "We will be looking at low-risk, established forest markets, in countries where we can see quantified established returns," he says. These include North America, the more established areas of South America, New Zealand, Australia and some of the new EU member states.
"We want to reduce political risk," Lacey says. "If our investors wanted to take more risks, they would invest in equities."
IFUT is not the only group looking around to broaden the investment base for its clients. In fact, as more and more institutional investors start to invest in timberland, profitability will be squeezed somewhat.
Although timberland investments have historically yielded annual nominal returns of about 15%, the IWC expects an international diversified timberland portfolio to yield an annual nominal rate of return of 10% to 12% before tax and asset management fees.
"With increased interest come increased competition for deals," says GMO's Greger. In her view, the biggest risk in forestry investment is that "like bonds, purchase price is crucial". So as forestland grows more expensive, it will be harder to maintain that same level of profitability.
In the European investment context, the newer EU member states offer potential, and Lacey of IFUT says that he has seen some speculative deals in some of the eastern European countries. Russia also holds some potential, although the situation there is quite different: rather than owning the land outright, investors can get concessions to
harvest the land.
"In the future, I think we will see interest in Russia as a timber investment," says the IWC's Reventlow. "Investors have to accept and understand its special characteristics." GMO's Greger is not in agreement, however. "We are long-term investors who make money by growing trees. We need secure title - we're not timber miners."