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Investors Increase Timberland Holdings

Eight Percent of "Investable" US Forestland Held by Investment Managers

From the December 2004 issue of The Forestry Source

By Steve Wilent

Any financial transaction worth $3.7 billion is big news. In November, Boise Cascade Corporation sold its 2.3 million acres of US timberland and its paper and forest products divisions to Madison Dearborn Partners LLC, a private equity investment firm based in Chicago. Although the transaction was large, it was not unusual. According to the Warnell School of Forest Resources at the University of Georgia, more than 23 million acres of forestland have changed hands in the past five years, more than half of which were purchased by financial institutions.

"The transition of land ownership from consolidated forest products companies to stand alone financial ownership is a huge trend," said Bettina von Hagen, vice president, Ecotrust Natural Capital Fund and Forestry Program"In the past 15 to 20 years, it's gone from virtually no land held by separate financial funds to about $15 billion worth of holdings, and the trend appears to be accelerating."

Hancock Timber Resource Group estimates that institutional investors currently hold about 8 percent of the investable timberland in the United States. According to Timber Mart-South, a newsletter published by the Warnell School of Forest Resources, by the end of 2003 the top 10 timberland investment management organizations (TIMOs) managed more US timberland — about 9.4 million acres — than the largest forest-products company, International Paper, which owns 8.3 million acres.

Some analysts predict that TIMOs and other investor groups will purchase another 10 to 15 million acres in the next decade.

One reason so much land may be available for purchase esthete financial markets had traditionally undervalued timberland.

"Part of the reason is the sense that Wall Street was not properly assigning value to the forest lands held by consolidated forest products companies," said von Hagen. "The theory is that these lands receive the appropriate value if they are held as single entities."

What's more, much of this land had been held for decades by companies that focused on supplying their mills rather than managing timber as a profitable enterprise.

"There were subsidies between mills and forestlands, and some of those forestlands supported inefficient mills, for example, or the mill would pay non market prices for the timber," von Hagen said.

As separate entities, investors see the potential for stable, long-term growth.

"Financial markets now see forests as valuable assets,making managed timberlands more attractive to investors," said Hal Salwasser, dean of the College of Forestry at Oregon State University. "TIMOs in particular have powerful incentives to manage forestlands for solid returns to investors, often increasing their value and productivity over time."

What's a TIMO?
Whereas public-equity companies such as Plum Creek Timber Company and Rayonier Inc. own the lands they manage on behalf of investors,most TIMOs do not own land.

"We're actually investment advisers," said Clark S. Binkley,managing director and chief investment officer for Hancock Timber Resource Group Inc. "Hancock owns literally no forestland. It's all owned by investors."

Hancock, a subsidiary of Manulife Financial Corporation, is the largest TIMO in the United States. It manages more than 3.2 million acres of timberland valued at $2.9 billion. Its investors include pension funds,insurance companies, corporations, foundations, and endowments. Hancock employs its own foresters and other property managers; most Limos rely on third-party forest managers.

Binkley says there are two main timberland investment models: separate accounts and closed-end funds. Separate accounts typically involve an individual investor or financial entity that purchases timberland with the intent to manage it for returns over an indefinite term.

"Separate account programs don't have a planned end — they may end, but they are essentially open-ended," said Binkley.

Closed-end funds involve multiple investors who together purchase timberland and hold it for a set period, such as 10 to 15 years,before selling it. Binkley estimates that roughly half of all TIMO investments are in closed-end funds.

"About 85 to 90 percent of our business is in open-ended accounts — there's no structural reason why we have to sell the trees,"said Binkley.

What happens when a closed-end fund matures? Therein lies one of the main criticisms of TIMOs: The land is likely to be sold, potentially to new owners who are not in the forestry business.

Investment Cycles
Ecotrust's von Hagen says TIMOs have strong incentives to sell lands after holding and managing them for 10 to 15 years.

"For investors who are holding timberlands, as they would hold any other financial asset, a lot of the returns are achieved through capital appreciation of the lands and the forests on them," said von Hagen. To realize that return, you need to have a sale."

"It's not clear what will happen after a couple of these cycles, in terms of maintaining intact, large forested landscapes," she said."We're really at the beginning of this — most of the growth in TIMOs has come in the past five years — so it's a good time to think about what this means"

When TIMOs put forestlands up for sale, they naturally seek the highest sale price they can get, which can lead to forest fragmentation.

"One way to increase the value of the forest lands to be sold is to break them up into smaller pieces and get retail prices rather than wholesale prices. And the way to get really high returns on their investment is to sell the land for what is known as the HBU, or highest and best use — which means development. Any opportunities to parcel out land and develop it are generally pursued quite vigorously."

Mike Clutter, a professor at the Warnell School of Forest Resources and author of an upcoming study funded by the USDA Forest Service,spoke about trends in forest ownership.

"TIMOs have been one of the major buyers of timberland over the past five years, and they've also been fairly active sellers during that period They've got some closed-end funds that they are starting to resell,"said Clutter.

Although Clutter's study is not yet complete, his preliminary data suggest that about 70 percent of the properties sold by TIMOs are purchased by other TIMOs or forest management companies. Of the remaining 30 percent of the land, some stays in timberland and the rest goes to other uses.

"Some of that 30 percent goes to the 'highest and best use,'which is often for development, and some goes to private individuals. Some of these people are buying land for timber management purposes, but a lot of them are looking for recreational opportunities — hunting, fishing,bird watching, and that kind of thing. And these buyers are willing to pay a little bit more than someone would pay for raw timberland," said Clutter.

The study will also determine the extent to which forest fragmentation occurs after TIMO lands are sold.

"There appears to be a little bit of fragmentation when that kind of sale occurs, but it's not pronounced," Clutter said.

It's not only TIMOs that are selling lands.

"A lot of the large, traditional integrated forest products companies — like Plum Creek and International Paper — have gotten a lot more aggressive with real estate development and the identification of HBU properties and then monetizing those properties," said Clutter. "It's not just any one group — all groups are recognizing that it's a component of generating the returns that are expected from their property."

Binkley says long-term forest management is key to Hancock's investment strategy: "We manage very intensively, especially in our southern and western plantations — as intensively as any of the industrial managers. That means intensive site preparation, selection of the best genetically improved trees-we even have a seed orchard. And we belong to all of the regional tree-breeding co-ops. We do these things because we think we can add a lot of value for our investors through that kind of management."

Although Hancock does occasionally sell small parcels of land, Binkley says merely selling timberland does not cause fragmentation.

"The idea that when you sell timberland it is fragmenting the forest is precisely incorrect — it's an incorrect usage of a very important term," said Binkley. "We aren't typically changing land use. Virtually everything we sell stays under forest cover."

Investing in Certified Forests
In the three years since the 2002 merger of Mead and Westvaco to form Mead Westvaco Corporation, the Charleston, South Carolina-based company has worked to reduce its holdings from 3.2 to 1.8 million acres. It has sold more than 1 million acres of its land so far, and TIMOs have purchased most of it.

"The forest industry has done some 'right-sizing' over the past few years. In our case, it hasn't affected our self-sufficiency, " said Mead Westvaco's James H. Hill, vice-president, land acquisitions, sales, and minerals."We've looked strategically at our land base and disposed of lands that we weren't getting a lot of fiber from and reallocated those assets to more useful and higher-return investments."

Among those investments was the purchase of more-efficient equipment for its mills. The company also used proceeds from land sales to payoff corporate debt. Hill said most of the land Mead Westvaco has sold was faraway from its mills, unproductive, or both.

In some cases, such as with the 2003 sale of 629,000 acres of forestland in Maine and New Hampshire to Wagner Forest Management Ltd.,Mead Westvaco has retained the rights to the fiber. Wagner also agreed to maintain Sustainable Forestry Initiative® (SFI) certification of the forests.

Binkley says all of the lands Hancock manages in the United States and Canada are SFI-certified; its holdings in Australia and New Zealand,plus one property in California, are certified by the Forest Stewardship Council

"From our point of view, having regular third-party audits of what we do is very valuable," said Binkley.

Ecotrust's forest investment fund, a private equity fund being developed for accredited investors, would maintain perpetual ownership of its lands and seek both traditional and alternative sources of investment return.

"We see this as response to the challenge of the transition in forest land ownership," said von Hagen. "The idea is to manage the forest for the full array of products and services-not only timber, but also non timber forest products, such as carbon [sequestration], habitat, and recreational and scenic values-and to try and get revenues from those other services."

Wilent is features writer for The Forestry Source.

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