In this short article, I discuss the main characteristics of global forest investments together with their expected returns. The article is based on a recently published paper by Professor Frederick Cubbage (College of Natural Resources at North Carolina State University) and myself (NORSKOG). At the end of the article, there is a link to access the full paper, free of charge during the next 50 days. Have a nice reading!
Global Forest Investments and Returns
Institutional timberland investments began in North America and have grown significantly from virtually zero in the early 1980s to more than 100 billion U.S. dollars today. As the U.S. timberland market has matured, increased competition for assets and a decline in returns have occurred. Investors, especially non-USD denominated investors, have increasingly sought new investment opportunities in non-U.S. markets, especially Latin America, Australia, and New Zealand, as well as modest interest in Asia, Africa and Europe. Currently, most of the investment markets (i.e., pension plans, endowment and private equity funds, insurance companies, and foundations) rely on TIMOs to advise them about their investments in timberlands and to manage those timberlands on their behalf. REITs and wood industry continue to manage their timberlands and are mostly organized as publicly traded forest products companies.
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On the above map, you can observe the range of forest investments returns estimated by different studies that were published between 2015 to 2020. Based on the studies of investment returns at the stand level —not including land, administration, overhead, purchase, legal, and corporate costs—forest investments generate internal rates of return (IRRs) between zero and 30% and are likely the most influenced by biological growth and timber prices. However, other factors may have a significant impact as well, such as planting costs, management costs, land value appreciation, higher and better use (HBU) sales on parts of large timberland properties or country political stability. Overall, the published research has shown that timber stand investments can offer reasonable returns.
Forest Investments as Portfolio Diversifiers
Like financial securities, the prices of forest assets are directly related to changes in forecasted cash flows and changes in the market discount rate. However, what differs forest assets is that cash flows and especially returns are predominantly driven by wood prices and biological growth. Wood prices, like other commodity prices, are a result of wood supply and demand interaction. Biological growth that affects yield is completely independent of financial markets. Thus, given that returns in forestry are driven by different economic fundamentals than are stocks and bonds, forest assets have little correlation, or even negative correlation, with the prices of financial assets, providing a diversification potential in the mixed portfolio and could improve investment performance.
As a long-term investment, timberland has shown significant risk mitigation potential in pure forest portfolio through spatial, product and market selection. Timber can be used for a variety of purposes (e.g., building and construction materials, pulp and paper products, bioenergy or other wood biomass-derived bio-products like vanillin), offering the option to put the timber into a variety of products that add considerable value.
Forest Investments as a Hedge Against Inflation
Timberland is often described as an investment that offers a hedge against inflation but also against oil price risk. Inflation hedging has not seemed so important in the 21st century as inflation and interest rates have remained quite low, but there are notable exceptions in some countries, and the risk remains germane.
Timber prices, which are a major driver of timberland returns, are not always highly correlated with inflation. The scientific literature indicates that a geographically diversified timberland portfolio is required if investors want timberland returns to be positively correlated with inflation over the long term and that many international investors may find that U.S. timberland returns outpace inflation in their countries.
Liquidity and Natural Risks
Forest assets are often described as a relatively illiquid investments, with potential exposures to natural disasters. In general, illiquidity protects forests as an asset class from financial crises and inflation. However, due to a large span of investment possibilities in forest assets, this feature seems to be closely dependent to investment vehicle being used in each investment.
Biotic (insect, disease) and abiotic (fire, storms, floods) threats to forest investments are perceived as issues, but not that prevalent. The impacts of insects and diseases on forests vary from natural thinning to extraordinary levels of tree mortality. Regarding random events such as wildfire, insects, diseases. A study done by Hancock Timber Resource Group (HTRG) showed that historically annual per cent of timberland asset value lost to natural disasters are quite low, at less than about 0.5% per year. Jacek Siry et al. in 2018 found that tree mortality in the United States from insect and diseases amounted to only about 0.3% of all land area in the country, and the brunt of this would occur on older stands on public lands or overmature stands on private lands. In the U.S. about seven to eight million acres of forest are burned by fires in recent years. Based on a base of 750 million acres, this would represent less than 1% of the country’s forests. Again, much of this is focused on public lands and the West, but private (investable) lands still bear some risk.
In sum, biotic and abiotic risks can affect forests, but they are much less than presumed. Insects and diseases are less likely to attack managed forest stands, with a likelihood of mortality of less than 0.2% per year. Fire is the greatest threat, but also less common on managed investment forestlands, at less than 1.0% per year for all forests in the U.S. with the vast majority on western, mostly public lands. The same concerns Australia:
Hurricanes and storms do affect productive forests, but major ones such as Hugo and Michael are uncommon, so the net effect is probably less than 0.2% to 0.5% per year. Storm damage is at least as likely to affect business, commercial, residential, or agricultural property, with much greater losses. Urban real estate property damage also is possible from fires and even social protests.
And major recessions will affect all sectors; perhaps much more than timberland…
This is just an excerpt from a recently published paper by Professor Frederick Cubbage (North Carolina State University) and myself, entitled “Research trends: Forest investments as a financial asset class”.
Moreover, in the article you will learn about:
- Investment Science History (What was the First Industrial Timberland?)
- What are Five Factors Facilitating Timberland Investments?
- Global Forest Land Ownership Patterns
- Forestry as an Alternative Asset Class
- What are our conclusions and outlook on Future Research?