The timberland investment sector is currently undergoing a fundamental change in the nature of the capital that is being employed, the investments that are being made, and the type of investors that are investing into the sector. When this asset class emerged in the 1980’s, pension capital primarily from corporate and public “defined benefit pension” plans was invested through closed-end, co-mingled funds in U.S. industrial forestlands that were being spun off from integrated forest products companies such as International Paper Company, Union Camp, and Champion International. Returns were relatively high due to strong timber and timberland markets (particularly in the U.S. South), a reduction in U.S. timber supply from environmental set-asides, more intensive management of plantation forests, and a reduction in timberland management costs as timberland was managed for financial return rather than fiber security. At the current time, many smaller pension investors are leaving the space as risk adjusted returns have compressed, and funds are under increasing pressure to hold more liquid investments to meet pension fund cash requirements. This is particularly true for international timberland investments, which can provide higher risk adjusted returns, but also expose investors to shallow markets for both timberland and timber products, and to increasingly volatile foreign exchange fluctuations. Concurrently, timberland markets worldwide have become much more efficient as return drivers have become better understood, and global demand growth for industrial roundwood has slowed due to product substitution and changing consumer preferences for forest products.
As this investment class is evolving, it is likely that investors in timberland will become more concentrated and more specialized, moving away from co-mingled “blind pools”, and toward separate accounts targeting particular geographies, end-market exposures, or return profiles. Future investors will likely be larger institutional investors and sovereign funds at one end of the spectrum, or smaller high net worth individuals and family offices with “targeted investments” through separate accounts, “club” deals and even direct investments at the other. A new category of investors could be “impact investors” for whom regional or sustainable development objectives may balance or even out-weigh financial return as a primary investment objective.
Although the amount of investible timberland held by corporate, private and government entities remains significantly higher than current institutional holdings, growth in institutional timberland investment is expected to be modest over the next decade due to the return and liquidity requirements of investors. Over the next decade, the timberland investment sector may experience:
- A decline in the average size of transactions as larger industrial properties are dis-aggregated and re-cycled into the institutional investment market, and new investments are made in regions of the world where landownership patterns are characterized by smaller holdings,
- Consolidation within the timberland investment manager sector as growth slows and economies of scale and low management costs become key bases of competition,
- More proposed related party transactions by investment managers as managers try to maintain assets under management, and a much higher percentage of acquisitions from one investment manager to another,
- More direct investment by sophisticated investors who can provide their own tax and back office support in cooperation with more sophisticated regional property managers – the “TIMO light” model – effectively by-passing the formal timberland investment management service, and
- The continued growth of timberland REIT’s as investors seeking exposure to the asset class, opt for the liquidity that is provided by a REIT, rather than an asset, investment.