timber primer - timberland investment – …€¦ · 4 u.s. regional returns there are two...

T I M B E R P R I M E RT I M B E R L A N D A S S E T C L A S S O V E R V I E W

2

IntroductionTimberland is a relatively new asset class for institutional investors that first emerged in the U.S. in the early 1980s. Today, an estimated US$100 billion1 of institutional capital is invested in timberland worldwide, with most capital placed in the U.S (77%), followed by Europe (8.3%), Oceania (7.9%), and Latin America (5.3%). Approximately US$65 billion¹ is managed by Timberland Investment Management Organizations (TIMOs) like Campbell Global, and the remaining US$35 billion¹ is controlled by Real Estate Investment Trusts (REITs).

The primary reason investors initially consider adding timberland to their portfolio is diversification. Due to historically low correlation with other asset classes, natural inflation hedging characteristics, and relatively low risk, timberland investments have provided decades of attractive risk-adjusted returns compared to traditional asset classes (Campbell Global Internal Research).

Timberland should also be considered by investors searching for yield. Timberland’s cash flow has historically been a significant portion of its return, generated predominantly through biological growth, with relatively low ongoing capital investment. For example, from inception through 2016, The National Council of Real Estate Investment Fiduciaries (“NCREIF”) has generated total annualized returns of 11.98%, with the income (EBITDA) return accounting for 5.12% of total return.

Unlike an annual agricultural crop, timber’s long-term biological growth provides a unique opportunity to capitalize on periods of high pricing, while mitigating the risk of lower prices through deferral of harvest. Timberland offers further diversification through different age classes, geographies, species, products, and markets.

The risks associated with timberland can be broken down into two primary categories: physical and economic. While the economic risks (price, supply, demand, and liquidity) are similar to those of other asset classes, the physical risks associated with timberland are identifiable and generally manageable, with losses due to physical risks (natural disasters, pests, disease, animal damage, and theft) typically comprising only a fraction of a percentage over its long-term history.

In the following sections, we will provide investors with an introduction to timberland as an asset class, a high-level overview of its benefits relative to traditional asset classes, the main drivers of return, how to invest in timberland, and associated risks. Emphasis is given to United States since it is, and will continued to be, the most active timberland market globally.

1 RISI, (2014). International Timberland Ownership and Investment Database 2

3

Historical Timberland Performance Competitive Returns Timberland is considered a “real” asset. It is real in terms of a hard asset that you can see and touch. It provides a “real” rate of return, meaning it returns cash back to the investor and is positively correlated to inflation. Projected timberland returns are typically calculated in real terms (without the effects of inflation). In addition, timberland has a unique biological growth attribute. Even when timber is not harvested and sold as logs, the trees continue to grow in size and value.

NCREIF publishes a Timberland Property Index patterned after the NCREIF Property Index, which is well known for measuring commercial real estate returns. NCREIF compiles the data from members who submit return information specific to the properties they manage. This becomes the basis for the composite return figures for the timberland asset class.

Timberland returns, represented by the NCREIF Timberland Index, have outperformed stocks and long-term corporate bonds since 1987, as demonstrated in Figure 1.

Timberland return results can vary due to several factors. One such factor is the change in log prices. Short-term log price volatility is directly affected by fluctuations in the regional supply/demand balance, and can have a significant impact on income return. For instance, supply changes in the U.S. Northwest, related to removal of federal timber supply, dramatically affected prices and returns during the 1990s. Changes in long-term log price expectations of market participants ultimately have the largest impact on timberland values.

11.98%

10.16%

6.34%

3.28%

Figure 1. Timberland, Commodities, Bonds & Stocks | 1987-2016

Source: NCREIF, S&P, Bloomberg

NC

RE

IF To

tal T

imb

er In

dex

S&

P 5

00 In

dex

Bar

clay

s A

gg

. Bo

nd

Ind

ex

S&

P G

SC

I

4

U.S. Regional ReturnsThere are two generally recognized timber-growing regions in the U.S. Each of these regions exhibits different return profiles based on the time it takes timber to grow (average rotation age); dominant product mixes (i.e. sawtimber or pulp); species; the ratio of private to public ownership; the demand trends for the species in these regions; the ratio of export to domestic sales; and other regional, national, and international economic factors.

In the Northwest, western hemlock and Douglas-fir constitute as much as 90% of the commercial volume, while species such as cedar, ponderosa pine and other fir species account for about 10%. The rotation age is typically 45-60 years. In the Southeast, the dominant commercial species is Southern yellow pine, accounting for about 80% of the commercial volume. The other 20% includes a variety of other pine and hardwood species. The rotation age is usually between 20-40 years.

The returns for the two regions are shown in Figure 2. The returns are from the NCREIF Timberland Index sub-regions. The Northwest has outperformed the Southeast based on annual average return since inception.

Historically, this performance differential has been driven by the Northwest’s access to diversified end markets, including export markets in the Asia Pacific region.

15.91%

9.13%

Source: NCREIF

Figure 2. U.S. Northwest & Southeast Historical Returns | 1987-2016

No

rth

wes

t

So

uth

east

5

Inflation HedgeTimber provides an inflation hedge, given its value is not heavily reliant on financial markets. Private-equity timberland market participants, like TIMOs, tend to use fundamental valuation methodologies in their valuations of properties, which may also contribute to timberland’s inflation hedging ability. In contrast, public-equity timberland investment vehicles have not historically shown the same robust attribute. A typical correlation analysis between selected asset classes and actual inflation, as defined by the CPI-U price level measure, is shown in Figure 3. This simple measure suggests that, over the past three decades, timberland returns have a higher correlation with inflation, providing inflation hedging results that are comparable to Treasury Bills and Commodities.

Figure 3. Correlations of Selected Asset Class Indices to Inflation | 1987-2016

Figure 4. Sharpe Ratio | 1987-2016

(1) Barclays renamed Lehman Aggregate Bond Index to Barclays Aggregate Bond Index in November 2008.(2) S&P renamed Goldman Sachs Commodity Index to S&P GSCI in May 2007.

NCREIF Timberland

0.81

Barclays Aggregate

Bond Index (1)0.64

NCREIF Commercial Real Estate

0.57

S&P 5000.40 Russell

20000.34

NAREIT Equity (REIT's)

0.31

MSCI EAFE (International)

0.12

S&P GSCI (2)0.00

Perfect Positive Correlation

Perfect Negative Correlation

Attractive Risk-Adjusted Returns Over the last three decades, timberland has generated higher returns than equities, fixed income, bonds, and several other asset classes, with less volatility. Figure 4 illustrates this point by showing the Sharpe ratio of the NCREIF Timberland Index against other asset classes.

Sources for both figures above: NCREIF, NAREIT, Morningstar, S&P, Federal Reserve

-0.10

-0.04

-0.02

0.09

0.16

0.24

0.48

0.69

0.73

-1.00 -0.75 -0.50 -0.25 0.00 0.25 0.50 0.75 1.00

NAREIT

Russell 2000

NCREIF Real Estate

S&P 500

MSCI EAFE International

Barclays Agg. Bond Index

NCREIF Timberland

US Treasury Bill (90 Day)

S&P GSCI

6

Correlation of Returns Among Asset Classes Historical timberland returns have low, and in some cases, negative correlation of annual returns in comparison to other assets such as equities, fixed income, commercial real estate, and other real assets, such as agriculture. This low correlation supports the inclusion of timberland in a diversified portfolio, and indicates that lowered risk, as measured by the standard deviation of portfolio returns, may be realized by allocating a percentage of portfolio assets to timberland.

A correlation analysis between commercial real estate and timberland, as measured by the FTSE NAREIT U.S. Real Estate Index, and NCREIF Total Timberland Index, illustrates negative correlation (Figure 5). In general, real estate has not been correlated with timberland returns due to fundamentally different business and economic drivers.

Although timberland is often included in the real estate asset class, the characteristics of timberland differ significantly from commercial real estate. While both use real property or land to support income-generating activities, there are very few other shared economic attributes. Where land value for commercial real estate may comprise a significant percentage of total property value for core properties, this percentage is low for mature timberland. Other differences between traditional real estate and timberland include, but are not limited to, the following:

• Timberland is a growing asset, and requires moderate-to-low added capital investment over time relative to asset value;

• Timberland generates income through the harvesting and selling of trees (logs), which are a raw material sold to companies that produce a multitude of wood-based products;

• Timber can be “warehoused” indefinitely by simply not harvesting.

Figure 5. Correlations of Selected Asset Class Indices to NCREIF Timberland Index | 1987-2016

Source: NCREIF, NAREIT, S&P, Bloomberg, MSCI, FTSE Russell, Federal Reserve

Perfect Positive Correlation

Perfect Negative Correlation

(0.14)

0.00

0.14

0.19

0.20

0.23

0.24

0.24

0.48

0.59

(1.00) (0.75) (0.50) (0.25) - 0.25 0.50 0.75 1.00

NAREIT

NCREIF Real Estate

Russell 2000

Barclays Agg. Bond Index

MSCI EAFE International

NCREIF Farmland

S&P GSCI

S&P 500

Inflation - CPI

US Treasury Bill (90 Day)

77

•

Portfolio Diversification A cornerstone of Modern Portfolio Theory (“MPT”), introduced by Harry Markowitz and others, is the concept of seeking portfolios that lie along an efficient frontier. The efficient frontier is formed by a set of portfolios which exhibit the maximum expected return for a given level of risk. Diversified portfolios will generally exhibit less risk for a given level of return because specific risk can be reduced, and low, or negative covariance, provides a risk offset.

Efficient frontier analysis is quite sensitive to the parameters that are used. The results of the analysis can yield an efficient frontier that is mathematically sound, but unlikely to be implemented by a typical institutional investor. To address this, we constructed efficient portfolios under two different portfolio weight constraint scenarios. The first scenario constrains portfolio weights to a maximum of 75%, so no single asset class completely dominates the portfolio. In the second scenario, we applied portfolio weight constraints that more closely align with institutional portfolios’ asset allocations.

8

Scenario 1Portfolio Weights Limited to 75%

We first constructed an efficient frontier of portfolios whose asset class weights could rise to a maximum of 75% (Table 1). This series of portfolios provides a theoretical illustration of how timberland can enhance portfolio outcomes. It is unlikely that an investor would allocate 75% of their portfolio to a single asset class, but when the efficient frontier contains such portfolios, the benefits of adding timberland are clearly highlighted.

The analysis produced an efficient frontier with expected returns ranging from 2.50% to 7.65%, as shown in Figure 6. The benefit of diversifying a portfolio with private timberlands becomes quickly evident as Portfolio B (with timber) achieves higher total returns than Portfolio A (no timber) at any level of risk. For example, at a 7% standard deviation, the inclusion of timberland adds 100 basis points (“bps”) to the expected return in comparison to Portfolio A.

Table 1 | Portfolio Weights Limited to 75%

Asset ClassExpected

Return (Nominal)

Standard Deviation

Max Asset

Allocation

Equity - US Large Cap 6.75% 17.40% 75%

Equity - US Small Cap 7.00% 22.60% 75%

Equity - Developed Ex-US 6.75% 19.70% 75%

Equity - Emerging Ex-US 7.00% 27.45% 75%

FI - US Fixed Income 3.00% 3.75% 75%

FI - US T-Bills 2.25% 0.90% 75%

FI - US TIPS 3.00% 5.25% 75%

FI - Non-US 1.40% 9.20% 75%

Private Real Estate 5.75% 16.35% 75%

Private Equity 7.35% 32.90% 75%

Absolute Return (Hedge Funds)

5.05% 9.15% 75%

Commodities 2.65% 18.30% 75%

Private Timberland 7.80% 13.00% 75%

Source: Callan Capital Market Projections 2017, Campbell Global projections

Figure 6. Expected Returns for Portfolio Weights Limited to 75%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00%

Exp

ecte

d R

etur

n

Expected Standard Deviation

Portfolio B - With Timber Portfolio A - Without Timber

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00%

Exp

ecte

d R

etur

n



0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00%

Exp

ecte

d R

etur

n



99

Scenario 2Analyzing a Realistic Institutional Portfolio

As a demonstration of what may be a more realistic portfolio composition for institutional investors, our second analysis sets the portfolio weight constraints at levels that are more consistent with observed real-world portfolios (Table 2). As in the previous analysis, one efficient frontier curve includes timberland and one does not. The portfolio with timberland achieves lower risk across the various target returns examined.

In the second scenario, the analysis also produced an efficient frontier with expected returns ranging from 2.50% to 7.65%, as shown in Figure 7. Portfolio B (with timber) also achieved higher total returns than Portfolio A (no timber) at any level of risk. For example, at a 7% expected return, the addition of an investment in timberland increases the overall return to the portfolio by 110 bps, and the return gaps continue to widen as risk increases.

Table 2 | Analyzing a Realistic Institutional Portfolio

Asset ClassExpected Return

(Nominal)Standard Deviation

Max Asset Allocation

Equity - US Large Cap 6.75% 17.40% 100%

Equity - US Small Cap 7.00% 22.60% 30%

Equity - Developed Ex-US 6.75% 19.70% 50%

Equity - Emerging Ex-US 7.00% 27.45% 30%

FI - US Fixed Income 3.00% 3.75% 100%

FI - US T-Bills 2.25% 0.90% 100%

FI - US TIPS 3.00% 5.25% 100%

FI - Non-US 1.40% 9.20% 50%

Private Real Estate 5.75% 16.35% 30%

Private Equity 7.35% 32.90% 30%

Absolute Return (Hedge Funds)

5.05% 9.15% 30%

Commodities 2.65% 18.30% 30%

Private Timberland 7.80% 13.00% 30%

Source: Callan Capital Market Projections 2017, Campbell Global projections

Figure 7. Expected Returns Analyzing a Realistic Institutional Portfolio

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

0.00% 5.00% 10.00% 15.00% 20.00% 25.00%

Exp

ecte

d R

etur

n



0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

0.00% 5.00% 10.00% 15.00% 20.00% 25.00%

Exp

ecte

d R

etur

n



0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

0.00% 5.00% 10.00% 15.00% 20.00% 25.00%

Exp

ecte

d R

etur

n



10

Potential Tax Benefits U.S. Investment Tax Treatment For investors with taxable portfolios, timberland offers certain advantages related to the unique attributes of the asset. Current U.S. federal tax laws allow income from timber harvesting to be treated as capital gains. Federal law also gives timberland owners a tax deduction known as depletion, which is the annual cost assigned to timber harvested. This is similar to the annual depreciation allowance for tangible assets such as plant and equipment.

As a result, for a taxable investor, timberland should almost exclusively generate significant cash flow that solely consists of capital gains.

In the Northwestern U.S., at the state level, many property tax codes have been modified to tax timberland on bare land value only and not on the value of standing timber, deferring tax on timber value until harvesting or stumpage sales generate cash income. Some states are paid severance or harvest taxes only when the timber is harvested.

Campbell Global has developed LLC and private REIT structures to provide most investors with tax-efficient investment vehicles. For tax-exempt investors, income generated from timberland can typically be structured to reduce Unrelated Business Taxable Income (“UBTI”). Campbell Global manages the UBTI issue through the use of an LLC structure for both separate accounts and commingled funds. Within the REIT structure, the IRS has ruled that amounts distributed as dividends by a qualified REIT do not constitute UBTI.

Global Tax Treatment With respect to tax considerations, an investor should be committed to taking prudent steps to mitigate the overall tax burden on global timber investments and may need to rely on professional tax and legal advisors for guidance in this area. Based on prior knowledge and experience, most investments can be structured so that minimal withholding tax is paid with respect to ongoing operations (i.e., distributions), although a one-time capital gains tax is almost always due upon exiting investments. A basic approach to minimizing tax may include: creation of a levered “in-country” capital structure; creation of an offshore holding company (e.g., Netherlands or Bermuda pass-through company); use of “hedged” in-country debt; optimizing “in-country” tax accounting rules (e.g., expensing versus capitalizing various forestry costs); and optimization of the benefits of tax treaties between the countries in which the timberland investor(s) and investment(s) are domiciled.

10

11

Figure 8. Typical Timberland Investment Return Attributes

58%Biological Growth

30%Timber Price Changes

8%Land Value Changes

4%Non-Timber Income

Source: Campbell Global

Components of Timberland Returns Total timberland return is comprised of four main components: biological growth, timber price changes, timberland value changes, and non-timber income, as depicted in Figure 8.

Biological Growth Biological Growth is a unique component that separates timberland from other investment types, such as real estate, stocks, commodities and bonds; providing asset appreciation independent of economic and financial markets. Timber literally grows in size and value over time, and the benefit of biological growth is twofold, as illustrated in Figure 9: as trees mature, they add more value by gaining more volume, translating into higher-value forest products.

For example, in Southern U.S., at age 14, dominant class loblolly pine trees are approximately seven inches in diameter, reaching pulpwood size, which is used to manufacture paper and packing products. At age 19, trees are around nine inches in diameter, growing into chip-n-saw products, mostly used to produce intermediate-value products like small dimension lumber and composite building panels. By age 25, trees have a diameter of approximately 13 inches, and are classified as sawtimber, that can be used to manufacture plywood, paneling, furniture, and flooring, the highest value products. It should be noted that the biological growth can vary widely, based on species, growing conditions, climate, and management practices. Campbell Global employs cost-effective active management practices that attempt to maximize and enhance the biological growth rate.

5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28Age

Pulpwood

Chip-n-saw

Sawtimber

Figure 9. Biological Growth and Product Changes of Loblolly Pine in U.S. South


12

Active Management • Actively managing timberlands can

also add significant value and increase financial return, while at the same time reducing risk. Campbell Global applies numerous innovative active management strategies to drive value and reduce risk. Examples of some of the strategies used include:

• Optimizing the selection and rotation of harvest units by employing advanced modeling techniques;

• Planting genetically superior seedlings;

• Controlling competing vegetation;

• Alleviating forest nutrient deficiencies through selective fertilization;

• Enhancing timber growth and quality through commercial and pre-commercial thinning;

• Controlling natural hazards like fire and insects;

• Preserving overall forest integrity, including wildlife habitat and water quality, by employing management techniques appropriate to specific forest types and sites;

• Obtaining harvest and other necessary permits on a timely basis; and

• Managing stewardship projects and initiatives to enhance the environment and mitigate risk.

Over the life of a timberland investment, timber value can be “stored on the stump,” giving investors the latitude to realize cash returns when timber market demand and pricing dynamics are most favorable. Timber harvest can be adapted to timber price movements to reduce market exposure and mitigate risk. In periods of weak pricing, a portion of the harvest can be delayed until pricing improves. Unharvested trees, due to the biological growth component, continue to grow and add value over time. When used effectively, this cash flow flexibility can lower the standard deviation of timberland returns, mitigate short-term log price fluctuations, and augment price increases.

Timber Price Changes Timber prices are derived from the demand for wood products. As end-product prices fluctuate, so do the prices for wood fiber. While short-term price fluctuations impact the cash return generated from a property, short-term price changes have not historically translated into large changes in timberland values. This is partly due to expectations that market participants will defer harvests in weak markets. In addition, most participants will use a discounted cash flow model with a price forecast that converges on a long-term trend price that tends to stabilize value. Changing expectations surrounding long-term price trends do impact price forecasts used in timberland valuations, and might influence the overall investment return.

Land Value Typically, land value accounts for a smaller portion of the total timberland investment return. The bare land value fluctuates based upon the supply and demand of the land available for timber production as well as changes in demand for the land for alternative uses, like agriculture, recreational use, bioenergy production, and “higher and better use” (“HBU”). Changes in demand for alternative uses can provide upside potential to land value because of increased appreciation, and may contribute more to total return than what is typical.

Non-Timber Income Recreational licenses and leases for hunting and fishing, mineral rights, right-of-way, mitigation banking, and carbon offset markets are examples of non-timber income sources that provide opportunity to add value to timberland investments.

12

13

Ways to Invest in Timberland There are public and private timberland investment vehicles available to investors interested in investing or accessing the timberland asset class. Public investment vehicles, including REITs and Exchanged-Traded Funds (“ETFs”) offer the most accessible ways to invest in timberland and provide the most liquidity. However, compared to private alternatives, publicly- traded vehicles offer investors little to no control over asset management and often come with significant manufacturing assets, so are not pure investments in timberland.

As an alternative to REITs and ETFs, investors may directly purchase timberland property through separate accounts or commingled funds, relying on TIMOs to build and manage their timberland portfolios. Separate accounts require high capital commitments, but offer the most control over investment term, risk profile, and strategy. Commingled investment funds offer greater diversification to investors who lack the minimum capital commitment to invest in separate accounts. Typically, they require 8- to 15-year investment periods, with low liquidity. A high-level summary of investment vehicles can be found in Table 3.

Table 3 | Typical Timberland Investment Vehicles

Investment Vehicle Publicly Traded Equity Separate Accounts Commingled Funds

Pros Relatively low cost High management control Lower capital commitment than separate accounts

Capacity to provide continuous market valuations

Maximum tax benefits Potential to offer greater diversification

Cons No management rights Requires high capital commitment

Longer investment lock-up period

Limited access to global timberland markets

Limited management rights

High exposure to market beta, reducing diversification benefits

Exposure to wood products manufacturing assets (not pure timberland)

Liquidity High High Moderate

Control & Flexibility Very Limited High Moderate

14

Risks Associated with Timberland Investments Specific risks associated with timberland investments can be classified into two major categories: a) physical risks, defined by factors affecting the quality or volume of timber output, and b) economic risks, associated with supply and demand. With proactive timberland and portfolio management, most risk factors can be positively mitigated. Campbell Global, through its extensive timberland management experience, has implemented numerous controls and policies to minimize physical and economic risks to its investors.

Physical Risks Physical risks, as they relate to timberland investments, vary greatly across geographic regions and climates. They include losses from man-caused and natural events such as fire, weather (including drought, hurricane, and tornado); insects (i.e., southern pine beetle); disease (i.e., fusiform rust); animal damage; and theft. These physical risks are negligible under most circumstances through proactive management, including rapid response to outbreaks of fire, insects, and disease present in the forest, and maintenance of healthy, well stocked stands of timber. Campbell Global has experienced minimum financial loss as a percentage of property fair market value (“FMV”) since inception (Table 4).

Table 4 | Campbell Global Historical Damage (>$500K)

Year Hectares Involved

Event Gross Loss Salvage Value1

Net Loss Net Loss as % of Property FMV

1994 890 Fire $644,000 $515,200 $128,800 0.35%

2005 81 Fire $1,121,500 $1,121,500 $0 0.00%

2011 1,214 Fire $2,844,978 $853,493 $1,991,485 0.32%

2011 2,061 Fire $5,000,000 $5,000,000 $0 0.00%

2012 477 Fire $819,687 $90,761 $728,926 0.42% 1 May Include salvage, insurance proceeds and third-party recovery.

14

15

Economic Risks Economic risks can pose the most material threats to timberland. These potential risks can be reduced through proactive timberland and portfolio management. Economic risks include:

Price

Log and stumpage prices are volatile. Price changes typically occur based on cyclical and seasonal fluctuations, and demand dynamics. The impacts of price volatility can often be diminished through active management, harvest scheduling, and diversification of a timber portfolio among log markets and regions. Campbell Global has decades of experience in log marketing and works diligently to maximize investor returns through appropriate market analyses.

Supply

Supply risk is composed of two factors: 1) productivity and 2) environmental constraints. Harvest scheduling and long-term planning incorporate these factors and typically minimize supply risk by enabling the forest managers to respond to price fluctuations in a manner designed to capture market opportunities. Campbell Global projects supply utilizing economic optimization techniques while providing flexibility for forest managers to accelerate or withhold supply in response to market changes.

• Productivity is a measure of the ability of forestland to grow trees. Risks include poor management practices that degrade site quality, or poor recognition of site productivity and the inappropriate application of otherwise sound management. Campbell Global’s silvicultural principles have historically minimized risks to productivity through active management such as silvicultural activities, which include planting genetically improved seedlings, fertilization, thinning, and weed and brush control.

• Environmental constraints are comprised of regulations associated with environmental protection and wildlife conservation. In the Northwestern U.S., the northern spotted owl, marbled murrelet, bald eagle, and various species of salmon have been listed as threatened or endangered species, resulting in changes in harvesting practices on both private and public timberlands. The red-cockaded woodpecker is a notable protected species in the Southern U.S. Numerous less notable species have also been protected in all regions. The protection of streams and rivers, archaeological sites and scenic areas are also examples of environmental constraints. Comprehensive due diligence at the time of acquisition minimizes financial risks associated with environmental constraints.

Campbell Global constantly monitors state and federal regulations that may impact forest management. In addition, we have established stewardship practices that meet or exceed industry standards minimizing environmental risks.

16

Demand

Changes in the demand for raw logs are driven by various external factors, including:

• Substitution of other finished products, such as steel or various recycled materials for wood products;

• Substitution of other wood products for domestic wood; for example, imported logs or finished products;

• Changes in overall demand for forest products related to usage, such as fluctuations in housing starts.

Demand risk is considered in both the semi-annual price forecasts performed by CG and the risk-adjusted rate of return analyses on specific acquisition opportunities. If demand risk is deemed high, the risk-adjusted rate of return will be increased appropriately to reflect the increased risk and thus, the property pricing will be decreased. If an increased risk exists under the current market conditions, CG expects the client to get paid for that risk.

Liquidity

Liquidity risk can be minimized through acquisition due diligence, sound stewardship principles, and the ability to identify and respond to disposition opportunities that enhance investment returns. The acquisition of well-managed properties, and the continuation of high-quality forest management typically enhance the value of a given property and maintain or enhance liquidity. As with many other risks, diligent active forest management based on sound investment objectives typically minimizes liquidity risk.

Currency Risk

With respect to currency considerations, “hedging” a fully equitized timber investment may not be economically justified, given the relatively high cost of hedging; the length of the investment period; and the fact that timber prices, especially in Canada, Australia, and New Zealand, are heavily influenced by the U.S. market (which is always priced in U.S. dollars). In addition, many export market driven international timberland investments are self-hedging since their exports are traded in U.S. Dollar denominated markets.

16

17

Timberland Valuation Valuation of timberland is typically based on the combination of “comparable sale” analysis and discounted cash flow analysis. These analyses reflect both wood-flow over time (for an entire property) and costs of operations. Professional forest managers, who practice intensive forestry, enhance the value and quality of the property, both in current terms and upon resale.

The most important assumptions that affect timberland investment values are the discount rate; base log prices; price forecasts; harvest schedules (particularly in the first ten years); logging costs; haul costs; road maintenance, and road construction costs.

Pricing has become more competitive over the last ten years, due to the following factors:

• Timberland valuation has become more sophisticated than in the past;

• Increasing number of bidders per sale;

• Declining average property size as the supply of large-scale timberland properties has diminished with reduced vertical integration within the forest products industry, and the break-up of large properties into smaller ones;

• Timberland is more widely recognized as an institutional investment asset class, increasing liquidity in the marketplace.

17

18

Global Forest Overview Forested Area and Harvest Levels The Food and Agriculture Organization of the United Nations (FAO) reports that the world’s forests cover 4.0 billion hectares (9.9 billion acres), with only 7% of this total in plantations. While North America accounted for 17% of total forested area in 2015 (Figure 10), these two countries accounted for 28% of industrial log production in the same year (Figure 11). These high production levels, plus the large area of investable timberland (i.e., privately owned, high volume, industrial grade timber) make North America the core region for any timberland investment portfolio.

Figure 11. Production of Industrial Roundwood | 20152015 Production: 1.8 billion m3

Figure 10. Total Forest Area | 20152015 Area: 4.0 billion hectares (9.9 billion acres)

Source: FAOSTAT, 2015

USA

South America

Europe (less Russian Federation)

Russian Federation

China

Indonesia

Oceania

Canada

Africa

Other

8%

21%

5%

20%5%2%

4%

9%

16%

10%

20%

12%

21%10%

9%

3%

3%

8%

4%

9%

19

The United States is the world’s largest consumer (Figure 12) and producer (Figure 13) of softwood lumber. Compared with many other countries in the world, the U.S. has a very strong tradition of wood use, directly reflecting the historical availability of wood. The United States is the dominant world softwood lumber consumer, using 22% of the world’s softwood lumber supply (FAO, 2015).

Figure 12. Top 20 Softwood Lumber Consumers | 2015

Figure 13. Top 20 Softwood Lumber Producers | 2015

Source: FAOSTAT, 2015 19

0 10 20 30 40 50 60 70 80 90

CzechiaItaly

PolandEgypt

AustraliaTurkey

ChileFrance

BrazilAustriaFinland

United KingdomAfricaJapan

SwedenGermany

Russian FederationCanada

ChinaUSA

Volume (millions m3)

0 10 20 30 40 50 60 70 80 90

LatviaUnited Kingdom

CzechiaRomania

New ZealandPolandTurkey

AustraliaFrance

ChileJapan

AustriaBrazil

FinlandSweden

GermanyRussian Federation

ChinaCanada

USA

Volume (million m3)

20

Changes in Plantation Area International forest products companies continue to expand into new regions, responding to opportunities arising from reductions in barriers to international trade and capital movements and shifting away from relatively high cost and highly regulated regions. Much of this expansion is taking place in countries, particularly in South America, in the form of eucalyptus plantations (planted forests). Increasingly important for investors is third-party certification, such as Forest Stewardship Council (FSC) and Sustainable Forestry Initiative (“SFI”), which ensure forests are managed in a sustainable manner. Resource availability is a key factor in determining timber production rates.

The biggest changes in resource availability are reflected in increased area of plantations (Figure 14). In 2000, timber harvest from both softwood and hardwood plantations accounted for about 35% of total industrial harvest (though only 6% of global forest cover). In 2005, the available wood for industrial use from planted forests was about 66% of global industrial roundwood production. This proportion could rise to more than 80% by 2030. Over the past decade, countries in Latin America and Oceania showed the highest percentage increases in plantations as presented in the chart below. These countries are showing the greatest increase in hardwood, primarily eucalyptus plantations. The major timber producers that rely mostly on softwoods, Russia, the U.S., and New Zealand, have shown very little plantation expansion.

Figure 14. Percentage Changes in Planted Forest Area

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Australia Brazil Chile Colombia New Zealand

Peru Russia Uruguay USA

2000-05 2005-10 2010-15

Source: FAOSTAT, 2015

21

Timberland Ownership Changes Traditionally, a large percentage of non-government timberlands have been owned by large, publicly-traded, integrated forest products companies, or smaller family-owned forest products companies. The timber on these lands has been used in company mills to produce paper, cardboard, panels, boards, beams and structural lumber for home and building construction, as well as a host of other consumer and industrial products.

In the early to mid-2000s, a fundamental change occurred in the ownership of a significant part of these commercial timberlands. Institutional investors, such as public and private pension funds, endowments, foundations, and high net-worth individuals, purchased large tracts of timberland from these forest products companies, and began selling the logs harvested from these lands on the open market (Figure 15).

These institutional timberland investments have generally been made through private equity limited liability partnerships, closed-end commingled funds, and separate accounts utilizing a limited liability company structure. These investment vehicles are now well established within the industry.

Private/Public Industrial

Private/Public Financial

REIT

Government & Conservation4% 7%

60%29%

Figure 15. Acquisition Value by Buyer Type | 2010-2015


22

Timberland TransactionsStructural changes in the ownership of private timberlands created opportunities for investors to purchase timberlands. Forest products companies were motivated to sell as a result of mergers and acquisitions, to raise capital for expansion, or to reduce debt.

Some large forest products companies sold non-strategic timberlands to focus on timber processing rather than on resource management. Individuals also have sought to realize profits on appreciating timberlands.

Since 1995, the increasing area of timberland transactions has been significant. During this time, over 28 million hectares (68 million acres) has changed hands.

Large-scale transactions have declined in recent years as the number of vertically integrated forest products industries has diminished. Many of the properties originally sold by these companies are expected to return to the market as the underlying investment vehicles mature, as shown in Figure 16.

-

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Hec

tare

s

U.S Non-U.S

Figure 16. Annual Area of Global Timberland Transaction

Note: Excludes REIT conversions Source: Campbell Global

23

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

Vol

ume

(mill

ions

m3 )

Import Production Export

International Trade As might be expected given its status as a net importer of forest products, the U.S. exports only a small proportion of its production (about 2%), as shown in Figure 17. However, these exports can be quite significant, as has been the case for softwood logs exported from the U.S. West Coast to Asia. In general though, U.S. domestic demand and a desire among importers to diversify their sources of supply are likely to constrain future exports of U.S. forest products.

Given the gap between production and consumption, the U.S. has long been and will continue to be a net importer of softwood lumber. Historically much of this volume has been sourced from Canada and this trend is likely to continue, although Canada has increased softwood exports to China in recent years. As shown in Figure 18, China has dramatically increased its softwood lumber imports over the past seven years. Despite a slowdown in Chinese economic growth, high demand for softwood logs and lumber is expected to continue in China for the foreseeable future.

0

20

40

60

80

100

120

140

Production Imports Exports

Vol

ume

(mill

ion

m3 )

Lumber Sawlogs

Figure 17. U.S. Softwood Production, Imports & Exports | 2015

Figure 18. China Softwood Lumber Production, Imports & Exports | 1961-2015

Source: : FAOSTAT, 2015

Source: : FAOSTAT, 2015

24

Conclusion During the past three decades, timberland has evolved into an attractive institutional quality asset class. Broad geographical diversification is possible and institutional capital has been deployed in North America, Oceana, Latin America, Asia, Europe, and Africa. Timberland investments can play an important role in investment portfolios given their attractive risk-adjusted returns, cash flow yields, low correlation with other asset classes, diversification benefits, and inflation hedging characteristics.

The unique biological growth component of timberland provides a growing inventory, and the ability to “store on stump” offers the potential to mitigate economic risks. Investors typically choose to access timberland through REITs, Commingled Funds, or Separate Accounts. Each of these vehicles has its own unique characteristics. Like other investments, there are risks associated with timberland, but they can be mitigated through active property management.

24

25

GlossaryAge: (1) Mean age of the trees comprising a forest, crop, or stand. In forests, the mean age of dominant (and sometimes codominant) trees is determined. The plantation age is generally established from the year the plantation was begun, without adding the age of the nursery stock. (2) Of a tree: the time elapsed since the germination of the seed, or the budding of the sprout or cutting from which the tree developed.

Age class: One of the intervals, commonly 10 or 20 years, into which the age range of tree crops is divided for classification or use. Also pertains to the trees included in such an interval. For example, trees ranging in age from 21 to 40 years fall into a 30-year age class; 30 designates the midpoint of the 20-year interval from 21 to 40 years.

Annual growth: Average annual increase in the biomass of growing-stock trees of a specified area.

Biomass: (1) Total woody material in a forest referring to both merchantable material and material left following a conventional logging operation. (2) All of the organic material on a given area or the burnable vegetation to be used for fuel in a combustion system.

Chip-n-saw: Registered trade name for a machine that makes small logs into cants, converting part of the outside of the log directly into chips without producing any sawdust. Cants are then sawn into lumber as part of the same operation.

Forest management: Generally, the practical application of scientific, economic, and social principles to the administration and working of a specific forest area for specified objectives.

Growth: Increase in diameter, basal area, height, and volume of individual trees or stands during a given period of time. Also known as increment.

Hardwood: Hardwood trees are generally deciduous trees that typically lose their leaves in the fall or winter and dominate the Northern Hemisphere. Hardwoods tend to be slower growing, and are therefore usually denser.

Plantations: Forests that are established by planting. These forests generally have higher input and maintenance costs, but much higher productivity than natural forests. Plantations are generally even-aged, planted and managed in rows, consist of a single species (sometimes two or three), and cover a large enough area to provide a suitable return on investment.

Precommercial thinning: Cutting trees from a young stand so that the remaining trees will have more room to grow to marketable size. Trees cut in a precommercial thinning have no commercial value and normally none of the felled trees are removed for utilization. The primary intent is to improve growth potential for the trees left after thinning.

Pulpwood: (1) Roundwood used as a source of wood fiber in a pulp mill. (2) Wood cut or prepared primarily for wood pulp and subsequent manufacture into paper, fiberboard, or other products, depending largely on the species cut and the pulping process.

Regeneration: (1) Renewal of a tree crop, either by natural or artificial means. (2) Young tree crop.

Rotation: (1) Period of years between establishment of a stand of timber and the time when it is considered ready for final harvest and regeneration. (2) Planned number of years between the regeneration of a timber stand and its final cutting.

Saw logs (“sawlogs”): Logs meeting minimum regional standards of diameter, length, and defect. Logs must be at least 8 feet long, have a minimum diameter inside bark of 6 inches for softwoods and 8 inches for hardwoods, and maximum defect as specified by regional standards.

Seedling: (1) Young tree grown from seed, from the time of germination until it reaches sapling size. (2) In nursery practices, a young tree that has not been transplanted.

Silviculture: Generally, the science and art of cultivating (such as with growing and tending) forest crops, based on the knowledge of silvics. More explicitly, the theory and practice of controlling the establishment, composition, constitution, and growth of forests.

26

Softwoods: (1) Botanical grouping of trees that are usually evergreen and have needle-like or scale-like leaves. Also known as conifers and coniferous trees. (2) Also the wood produced from such trees. The term softwood does not refer to the hardness of the wood.

Species: Group of similar individuals having a number of correlated characteristics and sharing a common gene pool. The species is the basic unit of taxonomy on which the binomial system has been established. The scientific name of a plant or animal gives the genus first and then the species as in Abies (genus) grandis (species). Species is both the singular and plural form of the word.

Stand: In silviculture and management, a tree community that possesses sufficient uniformity in composition, constitution, age, spatial arrangement, or condition to be distinguishable from adjacent communities. This tree community forms a silvicultural or management entity; for example, a subcompartment. Both natural and artificial crops are included, and there is no connotation of a particular age.

Stand age: The mean age of the dominant and co-dominant trees in the stand.

Stumpage: Value of timber as it stands uncut in the woods. Standing timber itself.

Thinning: Cuttings made in immature stands to stimulate the growth of the trees that remain and to increase the total yield of useful material from the stand.

Timber volume: Volume of growing stock – Volume of sound wood in the bole of sawtimber andpoletimber from a stump to a 4-inch minimum top diameter outside bark or to the point where the central stem breaks into limbs.

Volume of sawtimber: Net volume of the sawlog portion of live sawtimber in board feet.

Tree volume: The amount of wood in a tree. This may be expressed in board feet or cubic feet. It may be gross volume or net volume (gross less defects).

DisclosuresNothing in this document constitutes investment advice or a recommendation suitable or appropriate to a recipient’s individual circumstances or otherwise constitutes a personal recommendation. It does not constitute an advertisement and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments in any jurisdiction. This communication (i) is for reference only, (ii) does not constitute a financial promotion or other financial, professional, or investment advice in any way, (iii) does not constitute a recommendation, an offer to sell, or the solicitation of an offer to buy, (iv) is not the basis for any contract to purchase or sell any securities or other instruments in any jurisdiction, and (v) should not provide the basis for any investment decision.

This document has been prepared using publicly available information, internally developed data, and other sources believed to be reliable.

The information in this document is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. No representation, warranty or undertaking is given as to the accuracy or completeness of the information and opinions contained herein. No reliance may be placed for any purpose on the information and opinions contained in this document or their accuracy or completeness and nothing contained herein shall be relied upon as a promise or representation as to future performance.

Certain information in this document has been derived from materials furnished by outside sources. Although that information has been obtained from sources reasonably believed to be reliable, Campbell Global, LLC (“Campbell”) does not guarantee its accuracy, completeness, or fairness. Target investment returns, opinions, and estimates set forth herein are presented for informational purposes only and involve a number of assumptions that may not prove to be valid and may change without notice. Net returns are calculated and presented in a manner which is intended to illustrate the effect of management fees, organizational expenses, and performance-based compensation on overall investment performance. Certain target return data is based upon projections and future events, which are difficult to predict and are beyond the control of Campbell Global.

Certain information contained in this presentation constitutes forward-looking statements, which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “target,” “project,” “estimate,” “intend,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. The projections and forward-looking statements included herein are subject to risks, uncertainties, and assumptions. Some important factors that could cause actual results to differ materially from those in any forward-looking statements include the following: changes in financial, market, and economic or legal conditions, among others.

timber primer - timberland investment – …€¦ · 4 u.s. regional returns there are two...

Documents