Should Investors be Leaving the Forest?
Over the past several years, there has been growing circumstantial evidence that some institutional investors are cashing out of timberland investments in favor of more liquid, and perhaps better performing alternatives. The well-publicized exit of CalPERSs from much of its timberland portfolio, and rumors of divestitures by other longtime institutional investors supports a narrative of capital flight from the timberland asset class. While it would seem that net capital inflows are significantly less than they were in the first decade of this century, new capital does continue to replace existing capital as properties are cycled to new investors. The sector is more likely experiencing a “re-alignment” of capital with the new reality of timberland’s long-term performance, rather than a rush to the door.
Factors Fueling Re-alignment
There is no published information that documents the net flow of capital in and out of the timberland asset class. However, the number of funds and managers reporting results to the NCREIF Timberland Index might be indicative of the development of the asset class. Between 1990 and 2000, the number of funds in the Index increased from 11 to 60, and further increased to 109 funds by 2012. Between 1990 and 2012, the number of reporting managers also increased from 3 to 12. Between 2012 and 2017, the number of funds fell to 96 managed by a relatively stable number of managers. Though only representative, this metric is perhaps indicative of the slowdown in new capital coming into the space. A contributing factor has been the slowdown in the privatization or capitalization of industrial properties around the world since the global financial crisis. A review of transactions points to the fact that major landowners and governments have slowed the pace of offering assets to institutional investors throughout South America, Oceania, and Europe.
Investors have cited several reasons for moving out of the timberland sector including valuation volatility and a lack of performance metrics or benchmarks. The two most common complaints, however, have been lack of liquidity, and declining post-management fee performance since the global financial crisis. Both are legitimate arguments and reflect a changing investment climate that is currently struggling for returns, and seeks liquidity to rapidly move to and from investment alternatives.
One of the casualties of this changing investment climate has been a significant decline in the number of closed-end, co-mingled timberland funds on which the asset class was founded. The illliquidity of such funds has been exacerbated by the inability of managers to liquidate fund assets at appraised values, signaling asset over-valuation in some geographies. In an attempt to address the liquidity issue, the sector has experienced a growing number of investor controlled separate accounts and so-called “open-ended” timberland investment funds. Despite this, timberland remains a relatively ill-liquid asset class. Most timberland markets are not deep enough, and transactions not standard enough, to enable the sale or purchase of a timberland property in less than 6-12 months. Non-core investments in emerging geographies or auction transactions can take longer. As a result, the timberland asset class is likely to continue to be seen as a relatively ill-liquid, long-term investment.
Performance of course, is relative. Between 1995 and 2008, the NCREIF Timberland Index returned a nominal 9.33%/year, and handily outperformed both the S&P and Russell 2000 indices. Since the global financial crisis, the NCREIF Timberland Index returned a 4.0% nominal return/year, and significantly under-performed both equity indices. However, over the entire 1995-2016 time period, the NCREIF Timberland Index provided a nominal return of approximately 7.5%/year, outperforming both equity indices, with far less volatility. As buyers and sellers have become more sophisticated, metrics better understood, and markets more transparent, out-sized real returns in the timberland asset class are likely to only be achieved with commensurate risk. Investors seeking PE or VC returns, will probably need to look elsewhere.
The Persistent Case for Timber
It is important to recognize that, with reasonable acquisition prices, cash flow assumptions, and minimal leverage, it is difficult to lose capital in local currency in the timberland asset class. Biological growth and product/grade shifts alone support increasing asset values unrelated to market conditions. The few well-publicized timberland investment failures have resulted from efforts to achieve high returns in un-developed markets, overleveraged investments, or investments acquired using unreasonable cash flow assumptions.
As the capital structure of the asset class is re-aligned, it is likely that additional investors will withdraw and move capital to other asset classes. New capital from impact investors, generally less driven by returns, is likely to replace some sector participants, as will current investors who will and should remain, as the case for timberland in a diversified portfolio remains persistent.
For larger institutional investors in separate account structures, timberland offers improving liquidity, increasingly standardized valuation methodologies, and a proven hedge against inflation as the NCREIF Timberland Index registered a 2.5%/year real return between 2008 and 2017. Although correlations are higher than often advertised due to in-frequent valuations, larger investors also benefit from poorly correlated alpha that contributes to the over-all performance of a broader portfolio. In today’s climate of impact investment, timberland also offers well-established ESG credentials as well as opportunities to target investments for specific purposes such as species, water or ecosystem preservation, or regional sustainable development. For smaller investors, separate account structures or direct timberland investment provides all of these attributes and enables the generational preservation of capital. Direct timberland ownership can also lower management fees and maximizes liquidity, while avoiding the more market-related performance of equity timber ETF’s or REIT structures.
Finally, it should be noted that timberland returns over the past 20 years have provided consistent real returns in spite of, rather than because of, real increases in key timberland products such as softwood sawtimber. A recent multi-client study published by ForestEdge LLC and Wood Resources International found that the average price of softwood sawlogs for countries producing over 60% of the world’s conifer roundwood fell in real terms by nearly 1%/year between the year 2000 and 2016. This decrease resulted from a global over-supply situation caused in part by government and private investment in softwood plantations and productivity in the 1970’s and 1980’s. Conversely, since the year 2000, the area of softwood plantations in these same countries has stagnated and, in some cases, declined. The study projects that rather than continued real price declines, modest real increases in softwood log prices are likely over the study’s 2016-2030 forecast period.
After several decades of exceptional growth, the timberland investment sector would seem to be going through a period of capital re-alignment as some long-time investors exit the asset class, and others enter. The driving forces seem to be an investment climate favoring liquidity, and the evolution of timberland investment returns toward their appropriate risk-adjusted levels. Despite some well-publicized departures, the case for timberland investment within the portfolios of both large and small investors, if efficiently structured, remains strong.
Robert W. Hagler currently serves as Principal of ForestEdge, LLC, a Registered Investment Advisor, and timber investment manager and consultancy serving family offices and direct timberland investors.
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