Timber investment has evolved from a purely financial instrument to a better financial instrument that provides higher liquidity and a path forward for reforestation. It’s a powerful combination. Along the way, it can make a big contribution to the economies in remote locations that have limited opportunities for economic development.
Traditionally, timberland investments were limited to projects developed for timber harvests, feeding timber-related product markets such as lumber and other construction materials, pulp and paper, and bioenergy fuels. Investments in timber in this capacity are generally utilized to diversify investors’ portfolios and are largely sought after for their propensity for steady growth and subsequent capacity to hedge against inflation.
Historically, timberland investments have been limited by their low liquidity, with an average lock-up period of between 10 and 15 years. However, in the past decade, the emergent carbon market redefined forestry investments. Now, carbon credits can be derived from reforestation projects dedicated to carbon sequestration.
The carbon credit feature adds a new dimension to timber investments’ appeal. Prior reforestation projects were largely detached from economics. The carbon market connects forest investments to a global trading market and provides a ready source of liquidity that simply did not previously exist.
PERFORMANCE
Timber investments have always been a reliable source of growth and income as well as a hedge against inflation. Their performance has been no less than spectacular. On average, timber investments generate an annual return of 9.26 percent, outperforming non-U.S. equities by 400 basis points. The average return on U.S. equities is 200 basis points higher, but timber has lower volatility. This is because timber is a critical global commodity facing increasing demands as population increases and infrastructure develops.
This performance helps explain the growth of timber assets under management, which are expected to grow in the next decade from $535.96 billion in 2020 to $956.71 billion in 2030.
MARKET DRIVERS
Driving this growth are macro-trends in sustainability and ESG, which are increasing the demand for timber.
There has been immense pressure on the construction business to reduce their emissions. As a result, there has been a shift away from the use of cement in new construction. Changes in the International Building Code now allow mass-timber to be utilized in lieu of cement in structures taller than six stories; that is expected to increase to 12 stories in 2024. This shift in global policy is driving demand for mass timber. According to an Allied Market Research report, the global mass-timber construction industry is anticipated to generate $1.54 billion by 2031, an average annual growth of 6 percent from 2022 to 2031.
Similarly, there is a growing interest in alternatives to plastics, many of which are derived from paper or cellulose. As a result, the market for pulp, and other wood byproducts is expected to increase from $165.3 billion in 2020, to $242.1 billion by 2030.
Additionally, the rise in ESG initiatives has companies worldwide seeking out carbon offsets, driving demand for timberland carbon capture projects. Between 2016 and 2021, growth in voluntary carbon credit issuance increased by more than 300 percent with 285 million carbon credits issued in 2021. And with nearly 4,000 projects listed, or preregistered, the voluntary carbon-offsets market is expected to grow from around $2 billion in 2022 to about $100 billion in 2030.
TIMELY GROWTH
These market drivers are timely because interest in timber investment can be met not just with an investment vehicle, but an investment vehicle that can meaningfully support reforestation initiatives in areas where they are needed most.
For instance, invested funds can be employed by management teams to provide consistent care and monitoring of the timberlands to mitigate risks posed by natural hazards. In addition, cultivation practices promoting species diversification and the removal of pest-infested and diseased trees strengthens forests’ immunity, while undergrowth control, firebreaks and enhanced canopy density work together to prevent and mitigate risks of severe drought and wildfire damage.
While carbon credits have transformed the market, technology has played a role too. Infrared and drone technologies have been implemented to alert management teams of stressors, such as drought and pest infestation. There are also emerging sensor technologies that sense combustion and alert emergency response teams of ignition points before they spread out of control. In turn, managed forests have less than 1 percent risk of loss due to pests and extreme weather events.
Benefits of managed forests reach beyond the protection of forestry assets. Projects have been shown to support and restore the health of watersheds, regulating water supply, improving water quality and lowering water treatment costs. New York City’s watershed protection efforts showcase both the environmental and economic benefits of forest conservation. In the 1990s, the city invested $1.5 billion to protect more than 1 million acres of mostly forested watershed area in the Catskills, which feed the city’s water reservoirs, ultimately avoiding $6 billion to $8 billion on the cost of building a water filtration plant.
THE ‘S’ IN ESG
Aside from the multitude of environmental benefits, managed forestry stimulates positive economic growth. Forest management teams are assembled from local populations, providing reliable employment for local communities. An analysis conducted by a graduate student at the University of Massachusetts Amherst suggests an average of $140 per acre of USDA’s Forest Legacy Protected land is added to regional economies annually; in addition, FLP conserved lands support between 280 and 2,500 jobs depending on the region.
The other important social benefit of the “new” timber investing is focusing carbon credits on fulfilling their original mandate of reducing carbon emissions, not simply allowing polluters to continue polluting. By distributing reforesting carbon credits to companies that are earnest in their desire to reduce their carbon impact, timber investment managers can magnify the impact of their efforts.
The culmination of forestry investments’ consistent growth, accumulating market drivers, and associated environmental and social benefits are revolutionizing timberland investments. And forestry, once seen as a limited market, attracting only small portions of elite portfolios, is now an attractive investment to many, offering high yields and big impact.
Michael Ackerman is president and CEO of EcoForests Asset Management.