Seeing the forest and the trees in whole new ways

Timber is not only about the trees.

Returns have taken a nosedive — to the NCREIF Timberland index returning 2.38% for the 12 months ended March 31 from 9.69% in 2013 — due to an overabundance of lumber, dubbed "the wall of wood." So, timber managers are beginning to look beyond the trees to make money on their forestland portfolios as well as to transition the asset class as an antidote to climate change.

Timber managers have always bumped up returns by mining minerals, excavating rock deposits for construction and development. But now there is a rapidly growing market for alternative sources of income from the carbon markets, industry executives say.

Even pure-play timber managers are bumping up performance on the margins by investing in conservation finance, which seeks to gener- ate a profit through such mechanisms as carbon capture and wetland mitigation that also have a positive impact on the timber ecosystem.

Silver Creek Capital Management LLC, mainly a pure-play timber manager, does participate in conservation finance, said Bob Ratliffe, Seattle-based president of Silver Creek Capital.

"There's a certain opportunity, that is incremental to the return" in carbon capture and wetland mitigation, Mr. Ratliffe said. "But it's not a big part of the strategy," and Silver Creek is a core timber manager, he added. Silver Creek has $6 billion in assets under management.

Starting in around 2012 there has been a fast-developing market in ecological or conservation services allowing timber managers to generate cash flow from such activities as the sale of working-forest conservation easements, the leasing of land for wind turbines and the sale of forest-carbon credits, said Kaarsten Turner, senior vice president, ecological services at The Forestland Group, a Chapel Hill, N.C., timberland investment management organization.

Traditionally, the three components of return for the asset class were timber prices, land values and timber growth. The return can be affected by a variety of factors including home building, weather and environmental issues, according to a recent real assets report by Prudential Financial Inc.'s money management unit PGIM Inc. Younger trees produce lower-quality pulpwood, while older trees are used for higher-value sawtimber like veneer logs.

When demand for sawn wood, which is used for housing, falls as it did in the financial crisis, timberland returns also drop. Housing starts are up from their lowest point of 478,000 units in April 2009, according to the U.S. Census Bureau and U.S. Department of Housing and Urban Development. The 1,235,000 units started in April 2019 are up 5.7% from March but down 2.5% from April 2018, government figures showed.

Some managers are going all-in on the beyond-forest strategies. New Forests, a Sydney, Australia-based timber manager, formed the first institutional fund investing in forest carbon and mitigation banking. New Forests has A$5.2 billion ($3.6 billion) in assets under management.

New Forests' investment strategy is to manage forests to optimize revenues from a combination of timber harvest and carbon-offset sales, said David Brand, founder and CEO of New Forests.

Timber as an asset class started in the U.S., with roughly $100 billion owned by real estate investment trusts and institutional investors, with about 70% in the U.S., 20% in Australia and New Zealand and 10% in the rest of the world, he Mr. Brand estimated. The wave of capital seeking real assets means that timber is a sellers' market.

New Forests' investment strategy is to provide project finance and credit sales for forest owners that wish to participate in carbon-offset markets established by states such as California and governments around the world. Timberland owners can manage forests for both log sales and carbon-offset sales, providing additional current income while helping to transition a forest towards older stands and higher-value wood products, he said.

For example, in September, New Forests acquired 10,400 acres of Humboldt County, Calif., timberland from Soper-Wheeler Co. LLC. as part of a strategy focused on high-carbon-value forests, Mr. Brand said. Sustainably managed forests can mitigate the impact of climate change because trees trap carbon dioxide; if trees are destroyed, overharvested or burned they are a source of greenhouse gases.

Sustainable timber management including preserving forests rather than converting them to other land uses, ending forest degradation, and restoring peatlands, could avoid about 30% of carbon emissions, according to New Forests based on academic papers.

New Forests works with landowners to create carbon-offset projects that provide another source of revenue, Mr. Brand said. In Australia, New Forests has an emissions reduction strategy in which it grows the trees to larger sizes, generating more carbon stock. In New Zealand, New Forests is replanting on degraded land.

All of this is paid for by a complex and evolving system of carbon credits, carbon credit trading and wetland and wildlife mitigation. Governmental entities, non-profits such as The Conservation Fund and companies such as those in the airline and oil and gas industries are paying for carbon, wildlife and other credits to offset their carbon emissions and/or environmental damage on their properties.

The old timber asset class is being transformed into one that encompasses conservation and production as commercial businesses, he said. "It's a new (investment) opportunity. Let's see if we can reinvent the asset class into a natural infrastructure."

New Forests is not the only manager to make extra money with conservation. At Lyme Timber Co. LP, a Hanover, N.H., private timberland money manager, more than 85% of its invested capital is in working timberlands. But it also invests opportunistically in mitigation banks — a credit system to ensure that when development results in harm to wetlands, streams and/or natural habitats in one area, those assets are maintained or restored in another area so that there is no net loss to the environment.

According to a white paper on Lyme Timber by the Global Impact Investing Network, the firm also makes money through recreational leasing, sale of carbon-offset credits, alternative energy supply agreements, sale of mitigation credits and conservation easements in which the timberland owner forgoes exercising some of its rights to the land. Timberland comes with a bundle of other rights, including rights to mine the property for minerals and allow recreational use.

In July, Lyme Timber purchased 15,000 acres of timberland in Pennsylvania from Hancock Timber Resource Group. The timberland has been managed for high-value black cherry sawtimber production for more than 40 years.

But at the same time Lyme Timber entered into an option agreement to sell conservation easements that will permanently protect 51,000 acres, a news release stated. Another 9,500 acres will be protected by the donation of a conservation easement as part of a financing agreement with Pennsylvania Infrastructure Investment Authority, the state's clean water revolving loan fund.

American Timberlands Co., a timber manager that invests in timberland in the Southeast U.S., generates additional alpha through non-timber strategies such as mitigation, conservation and minerals, according to its website.

"We're investing in land that has options for management opportunities that will provide other returns," said Thomas C. Rowland III, managing director, CEO and co-founder of American Timberlands, in a company white paper. "We're looking for environmental mitigation, mining, commercial opportunities, conservation, and in a few cases, low-density real estate development."

The Forestland Group is also buying timberland both for the trees and to earn returns through conservation. In February, the firm sold 17,816 acres in Issaquena and Warren counties in Mississippi to The Nature Conservancy and state of Mississippi. Some 7,000 acres will be controlled by Mississippi's Department of Wildlife, Fisheries and Parks in coming years.

The Forestland Group was early into conservation because it owns predominantly hardwood which lends itself to carbon deals. Fewer trees are cut in hardwood forests than soft woods like pine forests which eventually end up cleared and replanted, said Hunter R. Jenkins, managing director and senior vice president of The Forestland Group.