Sometimes even open-ended structures are too constraining for limited partners.
The American Reforestation Company, a Dutch- and Costa Rica-based advisory and teak plantation management firm, is currently helping a European family office set up a special purpose vehicle to target Central American teak.
That is a departure from what ARC has so far largely been doing on the investment side. One of the company’s key endeavors has long been to plan, manage and harvest more than 2,300 hectares on behalf of the Central American Timber Fund, an open-ended vehicle valued at about $200 million.
The threshold for investing in CATF is low – €125,000 – and fees relatively modest – at 1.40 percent all-in annually, according to a 2015 prospectus. But Jaap Tol, real asset specialist at ARC, told Agri Investor that the family office it is currently establishing a plantation for was yearning for more flexibility than the fund offered.
“The family office first considered the fund, but then said they didn’t want a position in it. ‘We want to decide on our own, we want to be independent and flexible with respect to the day-to-day business management and exit strategy,’ they told us.”
Open-ended funds may be more flexible than closed-ended vehicles, but selling one’s stake and buying it back is not so simple, Tol said. Investing through the SPV, the family office will be able to decide when to harvest the wood, adapting to market shifts. Should prices stay cool, for example – and should it not need the cash – it will have the possibility to wait for better times.
Many investors considering Central American timber are US pensions looking to diversify their existing holdings, Tol noted. “You need a long horizon and to be prepared and able to provide working capital,” he said, specifying that such investments did not suit everyone.
Fleshing out the rationale for Central American teak, Tol presented it as one of the safer bets for those looking to diversify away from core timber markets. “In Costa Rica and Panama, legal entitlements are very clear. You are allowed to buy land and title rights. The political environment is stable, and you have a good workforce. The business environment is very good.”
Reaping mid-teen returns
The trade-off was also attractive, thanks to the high returns promised. ARC’s base-case scenario forecasts IRRs of 10-15 percent; in the most optimistic cases, performance can reach 16-17 percent. And if the environment turns sour – that is, if wood prices remain on hold amid sustained inflation in the broader economy – these investments will still generate a return, Tol said.
“The biological growth of trees is the most important driver of return. Because these trees become bigger in diameter, they eventually earn you more money.”
He was very optimistic about future demand in the wood’s main consumer markets. Nearly 70 percent of Central American teak goes to India, to be used in building houses, he estimated; China and Vietnam also buy a fair load of it.
With the Indian government pledging to provide affordable housing for all by 2022, the future indeed looks rosy.
“The bulk of natural teak used to come from Myanmar, but logging has been banned there since 2014. Plantation teak is now trying to fill the gap. But demand is bigger than production,” Tol said.