© Copyright 2006 Rogers Publishing Ltd. The following article first appeared in the January 2005 edition of BENEFITS CANADA magazine.
Timberlands are attracting more attention as an asset class from pension funds. Brascan’s Reid Carter talks about understanding timberlands from an investment perspective.
By James Lewis
Reid Carter, Managing partner, Timber Management Fund, Brascan Asset Management in Vancouver.

BC: Historically, what kind of returns have timberlands offered?
RC: In the early 1980s, most timberlands in the U.S. and Canada were owned by governments, or industrial owners, or small private owners such as woodlots. The industrial owners—the pulp and paper and forest products companies—started recognizing that these timberlands could be sold to institutional investors at [higher] multiples, so there was a big bump-up in the value of timberlands [from] the ‘80s to the late 1990s. Investors over that period saw an annual capital appreciation of about 7.5%, and then they had a cash-on-cash yield of about a further 6% or 6.5% from the sale of timber. So, the average over that period was about 13% or 14% total return.

After the stock market problems of 2000 and 2001 there was a real move to solid assets, and many of the institutional investors who had bought those large parcels from industrial owners—CalPERS being the biggest example—started selling their timberlands [in smaller] retail lots, at prices probably up to 50% or more above wholesale. So, that was the second bump-up: we saw industrial [selling] to institutional, then institutional to retail.

Over the past four or five years we’ve seen more variable capital appreciation, so total returns have fallen to around 6% to 7%. If you look at timberland auctions in the U.S., you’d see most of the auctions going at around a 5% or 6% [capitalization] rate, with expectations for further returns coming from the sale of non-timber opportunities within those lands or from some capital appreciation of the timberlands themselves. So, they may [believe] they’ll get a 7% or 8% return, but on a cash-on-cash basis they’re using a 5% cap rate. For Brascan, that isn’t good enough—we won’t invest our money at those kinds of levels.

BC: Can you tell me a bit about your fund?
RC: The Brascan Timber Management Fund was initiated in April 2003. Brascan has a long history of forest industry investments: they had a controlling interest in Noranda Forest, which then became Nexfor and is now Norbord and Fraser Papers. Until 1993, they owned 49% of MacMillan Bloedel, and they currently own two paper mills and about 300,000 hectares of timberland in Maine. They also own about 60,000 hectares of plantation forest in southern Brazil, and they also owned 50% of Northwood, which Canfor purchased in 1999. It’s considered to be one of the company’s core competencies. We take our own capital and invest with pension fund partners, so that keeps our interests aligned and we improve our returns through the fees we gain through the assets under management. Our investors—two to four each fund—are typically all large Canadian pension funds—we’re not looking for smaller investors. Brascan will be investing to quite a high level in the equity in these funds— somewhere between 25% and 50% will be Brascan’s money—so that gives us a spectacular leg-up when it comes to the financing of these opportunities.

BC: Is Canada a good source for timberland investments?
RC: There are three major areas of opportunity in North America. One is the auction market, another is the monetization of Crown lands through long-term leases, deeded rights opportunities and so on. The third is really more of a strategy: we have a strong balance sheet, we have other funding capabilities such as our Tricap Restructuring Fund, so we felt we could take on a little more complicated deals and look at companies that perhaps had pulp and paper assets, or sawmills, or other non-timber assets that might require some restructuring. There’s a whole series of companies in the U.S. that had a very significant component of their enterprise value in timberlands, but the overall company traded at more of an industrial multiple. So, we take on the restructuring of those companies.

I am [also] very excited about the investment opportunities in Brazil. We believe we’ll eventually have between US$300 million and US$400 million in timberlands there— that’s our goal, and it’ll take another year and a half or two years to get there. By April, we’ll probably have half that invested in Brazil.

BC: When people talk about timber, they talk about the cash flow of it as an investment as well. How does that work? Do you harvest some timber earlier in the growth cycle?
RC: The age-class distribution of the forest determines the harvest opportunity. Many Canadians have a lot of mature and immature timber, but not much middleaged. What you’re trying to achieve is an equal harvest and cash-flow opportunity each year. Through a combination of different harvesting or silvicultural systems and the use of thinnings to take out immature stands, we would be aiming to take out an equivalent value each year, although we will swing our harvest activity to suit market opportunities. A good manager, particularly one that doesn’t have quarterly cash distributions like a public company, will accelerate the harvest during good markets and let the trees grow on the stump during weak ones. You can only do that to a degree, because your variable costs are contractors, and you can’t just turn them on and off.

In coastal British Columbia, the rotation length— the time between harvests—is basically 35 to 60 years. Now, you may have some commercial thinning, or some other opportunity to go and get volume out in the interim, but the final harvest will be somewhere in that time frame. In Brazil, it’s about 18 years, and the volume produced is about five times greater than it would be in coastal B.C. on an annual basis. If you were in eastern Canada or the northeastern United States, you’d harvest on about a 65-year rotation, but the productivity is about onequarter to one-fifth what you’d find in coastal B.C., or about one-fifteenth what you’d find in Brazil. So, climate obviously makes a big difference, and the quality of the soil is a huge factor too.

BC: Are you selling the harvested product mostly on commodity markets?
RC: It depends where you’re buying it. In Brazil, we’re largely selling to furniture manufacturers. The residuals— the non-solid wood components—end up going to the pulp and paper industry. In eastern Canada or Maine, we sell almost exclusively to the U.S. dimension or SPF [spruce-pine-fir] market, which is for framing lumber, and to the pulp and paper industry. In coastal British Columbia, you’re selling products into a whole range of markets: 30% might be log exports to Japan, 30% might be log exports to the U.S. domestic sawmilling or converting industry, then your pulpwood is going to the pulp and paper industry. Because the coast has such a diverse range of products—cedar, old-growth Douglas fir, hemlock— it has much more diversified market opportunities.

BC: So there is a measure of protection there in the non-correlation of those industries…
RC: Yes, there’s a non-correlation between those industries, but also between the timberlands themselves; because you have this ability to let the trees grow on the stump, the beta or volatility of timber pricing is much lower than that of the underlying commodities. With sawmills, the profits may spike up and down dramatically, but the log seller doesn’t like to change his price much, so in a strong lumber market the sawmillers make a lot of money, but in weak markets they either don’t buy the logs and shut down, or their margins are awfully skinny. That’s been the history in North America: timberlands tend to have a much lower beta, but also have been positively correlated with inflation and negatively correlated with most of the major indices.

BC: Anything else institutional investors should know?
RC: This is an asset class that has been attracting a considerable amount of interest, but still may not be
really well understood. It’s an asset class that has very good opportunities, but you need to understand what you’re buying. Not all timberlands are created equal, and not all timberland managers are created equal. Because it’s attracting a lot of attention right now, you need to be careful. It’s like when anything else becomes popular—sometimes you wonder whether now is the time to be a seller rather than a buyer.

James Lewis is a contributing editor of BENEFITS CANADA.