Given that timberland is perhaps the longest of long-term assets, it is no surprise that investors have traditionally preferred the relative safety and predictability of established markets. While the asset class has gradually expanded from its origins in North America over recent decades, mainstream timberland managers have been hesitant to invest in emerging market regions.
But this could be starting to change, partly for the simple reason that forestry operations can deliver timber to market more quickly in regions where trees grow faster. “In tropical climates, you can grow forests two to four times faster than in temperate or boreal climates,” says Hanna Skelly, managing director at Arbaro Advisors, a subsidiary of German asset manager Finance in Motion. “It really makes a big difference.”
Several funds with a focus of tropical parts of Africa, Asia and Latin America have announced major milestones recently. Brazilian asset manager Mombak Gestora de Recursos closed a $100 million Amazon reforestation fund in September, after receiving commitments from major players including Canada Pension Plans Investment and alternative lender AXA IM Alts (which also took a minority equity stake in Mombak).
New Forests, meanwhile, launched its first Africa-dedicated investment fund in November 2021 and achieved a $200 million first close on the open-end vehicle in October 2022. The
Australian-headquartered manager has also been operating in Southeast Asia since 2008.
Geoffrey Seeto, head of emerging markets at New Forests, tells us that demographic and economic trends make it logical to establish commercial operations that are positioned to serve fast-growing markets. “You have a growing population, but also a more affluent population in these emerging markets,” he says. “There is a direct correlation between the use of wood products and GDP per capita.”
As well as serving local markets, timberland assets in tropical emerging market regions deliver products that are exported overseas after being processed. Likewise, the lower costs of land and labor support the economics of forestry in Africa, Asia and Latin America.
“Certainly, there are advantages of being able to grow that timber faster, but also, with a more competitive growing environment in terms of costs, we are able to be more competitive in terms of being able to sell that timber,” says Seeto.
There is no doubt that investor interest in tropical regions goes beyond strictly commercial considerations. Indeed, managers that operate timberland plantations that are certified by the Forestry Stewardship Council or other credible schemes have important advantages in attracting investment from sustainability-conscious organisations.
Seeto notes that investors and corporates increasingly recognize that growing timber intensively on a sustainably managed plantation can produce important conservation benefits, since it can “displace” demand for wood harvested from natural forests.
Tropical forests continue to experience some of the world’s highest rates of deforestation. Brazil lost almost 30 million hectares of primary forest between 2002 and 2022, according to the World Resources Institute. Indonesia lost 10 million hectares and the Democratic Republic of Congo suffered a loss of six million hectares over the same period.
Skelly agrees that the “increased scrutiny” of illegal logging is an important factor shaping the forestry market globally. In light of new regulations, she suggests that companies that manufacture timber products are likely to look for raw material suppliers that can prove that they produce forest products sustainably. The European Union’s deforestation regulation, which entered into force in June, requires that companies conduct due diligence to demonstrate that products imported into the EU are deforestation-free.
Of all the factors spurring interest in tropical timber production, perhaps the most consequential for the long-term is the development of carbon markets.
George McPherson, managing director at fund manager Criterion Africa Partners, says that his firm has typically relied in large part on development finance institutions, which have long understood the economic importance of commercial forestry. In recent years, however, the firm’s Africa-focused strategies have “somewhat suddenly” begun to receive interest from “new players who, 10 years ago, would not have given African forestry a second look.”
Their interest, he says, is “not necessarily for the return potential, but more for the carbon potential”.
“In terms of getting them to actually make fund commitments or co-investment commitments, it is still early days,” adds McPherson, who points out that potential investors include “huge corporates” that are seeking to invest in carbon offsets as part of their net-zero strategies.
As with other aspects of forestry in tropical regions, the faster growing cycles are a clear benefit when it comes to sequestering carbon. Fast-growing trees absorb more carbon, more quickly and for a corporate that may have a 2050 net-zero target, along with interim targets with deadlines in 2025 and 2030, newly cultivated tropical forests that can absorb carbon quickly is an attractive investment.
While there is excitement around the growing role of tropical forestry in the voluntary carbon market, all informed observers agree that the market is nascent – and that its trajectory is still uncertain. The credibility of carbon credits has not been helped by recent high-profile media reports on offsetting projects that wildly overstated their carbon sequestration benefits.
Most timberland managers still believe that the best way to operate in tropical regions is to seek to generate carbon credits from more conventional forestry operations – rather than investing in ‘pure-play’ carbon projects, where trees are grown to sequester carbon and are not harvested.
“We invest in forestry projects that have a solid economic back bone from the sustainable timber production and then the carbon benefits come on top,” says Skelly.
“It still makes abundant sense to manage existing forestry assets for their ability to grow trees and ultimately become high-value wood products,” adds McPherson.
Similarly, Seeto describes carbon credits as an “add-on” that can help generate alpha for investors. But he notes that the development of the carbon markets potentially makes greenfield timberland projects more attractive. Indeed, carbon credits for newly planted forests are far more valuable, given that they provide ‘additionality’ in removing carbon that would otherwise remain in the atmosphere.
Traditionally, the drawback for greenfield investments is that – even in tropical climates – “there is no cashflow for 10 years,” says Seeto. But carbon credits can begin to generate revenues well before trees are ready for harvesting, thereby fundamentally changing the economics of a project.
“It has been somewhat of a game changer,” says Seeto. “It’s allowed us to de-risk the planting of new areas from a cashflow point of view.”