Can Non-Timber Strategies Generate Cash for Timberland Investment Management Organizations?

Tim Gray of the New York Times wrote in 2017 that one of the best reasons for investing in timberland that “trees don’t watch the stock market.” These market-agnostic assets increase in size, and presumably value, over time regardless of prevailing macroeconomic factors, all while providing the well-established environmental benefits of a standing forest.

In addition to helping provide clean air and water, forests play a major role in offsetting anthropogenic carbon dioxide emissions. About 20% of the roughly 760 million acres of forest land in the United States is owned by private corporate interests. This scale of land ownership indicates that private managers have significant influence on both the environmental and economic services forests provide. However, the timber investment industry is facing a new set of challenges — challenges that may dictate a turn to a new set of business strategies.

More than a decade after the 2008 financial crisis, its effects can still be felt in the timber and forest products industry. The macro-economic headwinds and subsequent market changes have had a lasting effect, according to industry data group Forest2Market. The collapse of timber prices — attributed by High Country News to a variety of factors including the recession, increasing supply of cheap Chinese timber, and fluctuating material demand — has injected increased uncertainty on the economic viability of the U.S. timber market. Uncertainty in timber sale cash flows creates an issue for timberland investment management organizations (TIMOs); groups that help investors find, analyze, and acquire timberland investment assets. As the economics of maintaining large tracts of land for timber production have shifted, TIMOs could be vulnerable to going out of business and having their holdings developed into other land uses.

Compounding the issue of market fluctuations are the long timescales over which TIMOs operate. A decision to cut trees too early or late can result in compounded revenue loss, given that stands may take 20 to 30 years to regenerate. Fortunately, timberland assets are not limited to just the trees they contain. There are alternative sources of revenue that could supplement cash flows between harvesting years as well as mitigate some of the uncertainty facing the wood products industry. To explore how the industry is using non-timber strategies, CFN spoke to five professionals with TIMO experience — from Ecotrust, The Lyme Timber Company, New Island Capital, New Forests, and Con Edison’s Renewable Energy Investments about the strategies they are implementing and market trends they are tracking to generate returns from activities that keep trees in the soil.

Carbon Is King

In an interview with CFN, Lizzie Marsters, program director for forests and ecosystem services at Ecotrust, called carbon credits “the biggest bang for your buck right now” in terms of generating non-timber revenues from forest portfolios. Indeed, carbon crediting was cited by all of the TIMO managers CFN interviewed as the primary alternative revenue source for forests. As the carbon credit market continues to mature, the track record for deals stands to make it easier to establish programs, suggesting carbon will be an increasingly important complement to timber revenues in the future.

However, as Marsters points out, carbon crediting is not without challenges as well. Assets with a high established baseline timber level are often necessary to facilitate viable carbon crediting programs, as they can begin generating revenue fairly quickly. Without this baseline, it can take decades before the carbon content of a given property can be established to the point that credits can be issued. Additionally, with carbon prices not currently high enough to be competitive with other land uses, landowners often need larger holdings to spread a carbon program’s fixed due-diligence and implementation costs across a larger footprint. Even so, Marsters estimated that a carbon price upwards of $50 per ton, as opposed to the current price of about $18 per ton in California, would be necessary to truly make carbon crediting competitive with the harvesting all of the mature timber on a given property in most cases. While most carbon crediting programs allow timber harvest above the established baseline, much of the timber value of a property is locked up and unavailable for harvest.

Carbon crediting was cited by all of the TIMO managers CFN interviewed as the primary alternative revenue source for forests.

Carbon crediting can also face challenging time frames from an investor perspective. Crediting through the largest market in the United States, the California Air Resources Board, for example, requires a 100-year commitment to maintain the land after the credits are issued. Even if the immediate payouts were more lucrative, Utkarsh Agarwal of Renewable Energy Investments (formerly of Encourage Capital’s EKO Green Carbon Fund) suggested that many TIMOs may be less “excited about monetizing carbon because [they have] concerns it would place an encumbrance on their lands and pose a disposition challenge.” So even if sticking to timber alone might generate more modest returns, it provides managers with the flexibility to change strategies in the future.

Other Non-Timber Forest Opportunities

Beyond carbon crediting, there are several other options available to TIMOs to generate cash flows from non-timber sources. One of these strategies, used by organizations such as The Lyme Timber Company, based in the New Hampshire, and California investment advising firm New Island Capital, is the conservation easement, an agreement restricting future development on a property. Funds exchanged for this protection can flow immediately back to the landowner, significantly reducing the cost basis on a parcel of land and improving returns. Like carbon crediting, these types of agreements can be structured to allow for timber harvesting of growth over the pre-established baseline timber volume, allowing the landowner to realize continued revenues from timber.

Depending on the specifics of a particular forestry asset, there are also smaller non-timber strategies available to managers. Marsters of Ecotrust mentioned the sale of hunting rights as a significant additional consideration, particularly in the southern United States. Wetland and endangered species banking programs can also be a viable alternative for some TIMOs. However, Marsters indicated that the market for these opportunities can be sporadic and by their nature they are particularly regional. Lyme Timber has even made several downstream investments in log yards and a sawmill. As Marc Hiller, director of investments at The Lyme Timber Company, explained, these vertical integration efforts are less about the return profile of a log yard operation itself. Instead, the additional value derived from controlling the log yards directly comes from the ability it gives Lyme Timber to deliver specific timber products to customers based on need or preference; rather than having customers purchase all of the wood that comes out of a forest stand. This strategy cuts down on the amount of undesirable wood that mills must process and helps Lyme Timber to maintain a competitive advantage for its timber sales.

As the market for assets such as carbon credits continues to gain traction and grow, TIMOs generally appear to view alternative cash flow sources as a value-add rather than a value driver. Hiller noted that Lyme Timber attempts to identify potential non-timber revenue streams at the outset of an investment, but sometimes considers this strategy a matter of finding opportunities after the fact that were not part of the initial investment calculus.

Investor Considerations

Hiller’s point about timber revenue streams continuing to be at the core of the calculus of deals highlights a fiduciary duty challenge that was also raised by other TIMO managers. Most managers interviewed expressed some concern about potentially forgoing the steadier and more established returns of a traditional timber portfolio in order to chase revenue from carbon credits or other non-timber forest products. Radha Kuppalli, managing director of investor services at investment firm New Forests, explained that their investors are generally looking for stable investments in which they are willing accept lower returns in exchange for lower the lower risk that is characteristic of the timberland industry. Institutional investors, for example, are looking for solid timberland returns and will make riskier investments elsewhere. Hiller also mentioned that they do not specifically recruit capital for impact or mission. Although Lyme Timber has pursued several other non-timber cash flow strategies, the firm is primarily benchmarked to core timberland investments.

TIMOs generally appear to view alternative cash flow sources as a value-add rather than a value driver.

These trends seem to indicate that although TIMOs are in a position to potentially diversify their revenue sources and develop sustainability-driven assets, due to a variety of market forces, that can be easier said than done. A certain amount of inertia may be inevitable when dealing with institutional investors and long-running industries like forestry. It very well may take some time, and a more robust non-timber forest product industry to attract considerable investment interest from TIMOs.

The Path Forward

Creative use of TIMO-owned forestry assets can contribute to the construction a sustainable, low-carbon economy. But what changes need to happen to grow the market for this type of investment, and make the non-use value of timberland assets more attractive than logging or other development?

Policy stands out as one lever for change. The creation of additional state or federal carbon markets in the United States could make carbon crediting more mainstream. Additionally, more restrictive caps on carbon emissions in existing markets could drive up demand enough to push the price of carbon closer to the $50-per-ton threshold for viability alluded to by Marsters.

Another factor mentioned in interviews that could drive investment in non-use forest services was water resources. Sustainably managing forests can provide significant additional water resources to utilities, especially in the western part of the United States. Blue Forest Conservation and Encourage Capital’s Forest Resilience Bond pilot program has demonstrated utilities’ willingness to pay for increased water quality and availability. If the implementation of this type of financing increases, it could serve as an emerging model for TIMOs and other large land holders.

Regardless of the particulars of any given investment opportunity, our interviews indicate that in order to attract attention from TIMOs, investments should be low risk as well as not disruptive to core timberland activities. In the meantime, no matter the market, the trees will keep on growing.

Note: Peter Stein of The Lyme Timber Company is on CFN’s Advisory Committee. Radha Kuppalli is a member of the Yale Center for Business and the Environment’s Advisory Board.

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