When the U.S. housing market crashed in 2007, demand for lumber plunged along with it.
With fewer houses being built, fewer building materials were needed, and investors in U.S. timberlands — who had up until the financial crisis been seeing near-double-digit gains on their timber holdings — felt the blow of lower returns.
“We saw that asset suffer quite considerably,” says Neil Woods, portfolio manager at the New Zealand Superannuation Fund, a NZ$36 billion ($25 billion) pension with roughly NZ$2 billion in global timberland investments. “That caught us by surprise.”
Even as most other asset classes recovered from the crisis, U.S. timber performance remained “well below the historical average,” says Tom Johnson, a managing director at Timberland Investment Resources. But now, he adds, timber may finally be on the cusp of a resurgence.
In the decade since the housing market’s collapse, Johnson says, timber prices have stayed down despite rising levels of housing construction, largely due to a supply glut. The problem arose shortly after the market crashed, when timberland owners responded to falling demand by “storing on the stump” — letting trees continue to grow instead of chopping them down.
Usually, the ability to store lumber on the stump is hailed as one of the benefits of investing in timber. Not only are timberland owners never forced sellers, but the trees themselves can increase in value exponentially if they’re allowed to grow longer. Johnson says southern pines, for instance, can be cut for cheap pulpwood after around 14 years of growth. Wait 25 years, however, and those same trees will yield significantly more valuable saw timber — logs large enough to be cut into the dimensional lumber used for building.
“There’s no other asset you can invest in that grows on its own and becomes more valuable if you just walk away from it,” Johnson says.
Post-crisis, however, that blessing has become something of a curse. Robert Flynn, director of international timber at forest data firm and Euromoney Institutional Investor company RISI, says lumber producers have built up a backlog of timber to harvest, with the result that supply has continued to exceed demand even a decade later.
“Prices have remained flat,” Flynn says. “That’s really soured some of the major investors on timber.” Flynn points to the California Public Employees’ Retirement System, which is in the process of reviewing its timber portfolio. The pension fund’s forestland assets earned just 1 percent over the fiscal year ending in June 2017, according to preliminary annual report data from CalPERS. A spokesperson for the pension fund didn’t return a request for comment.
“The returns just haven’t been that great,” Flynn adds. “The TIMOs” — timber investment management organizations — “are now in reorganization mode, looking at better options to attract investors.”
One of these options has been evergreen, or open-ended, funds, which prolong the time period that timber investment managers hold onto investor capital. Other options have included co-investment and partnership models, like the structure employed by Silver Creek Capital Management-backed Twin Creeks Timber, a $1 billion venture whose investors include the California State Teachers’ Retirement System, the Washington State Investment Board, the Oregon Public Employees Retirement Fund, the Alaska Permanent Fund, and the Maine Public Employees Retirement System. The Twin Creeks fund, Flynn explains, is an example of several large asset owners partnering with a timber operator rather than just hiring a TIMO to manage forest assets.
“It’s an interesting time,” he says. “The old model worked very well for a while, but that time has passed.”
At the New Zealand Super Fund, Woods says they prefer to hold timberlands directly because of the fixed time frames imposed on timber funds. “The investments may take a few years to work, and with direct investing you can hold the assets for the time frame you want,” he says.
The bulk of NZ Super’s timber portfolio, in fact, is made up by the pension’s 42 percent stake in New Zealand’s Kaingaroa Forest. The fund first acquired an interest in the property in 2006, when it purchased a stake from Harvard Management Co. Woods says NZ Super also has smaller timberland investments through timber funds, which give the pension exposure to forest assets in Australia, South America, and Asia. A small interest in a property managed by Hancock Timber Resource Group makes up its U.S. holding.
Apart from the Hancock stake, Woods says, the portfolio has been performing “about as expected for timber,” delivering around 6 to 8 percent annualized returns over the long term. While lumber prices may be depressed in the U.S., Woods says, demand for wood is high in China — one of the biggest markets for New Zealand lumber.
“I was just visiting China and came away very positive about demand for imported wood, so from that perspective the medium term is looking very positive,” he says.
And lumber prices may soon be on the upswing in the U.S. too. According to Johnson, timberland owners are very close to working their way through the supply overhang that built up following the financial crisis. Houses are being built again — if not quite at the same pace as before the market crash — and demand for lumber has remained high in other segments like paper and packaging. Plus, Johnson says, a recent pine beetle epidemic in Canada destroyed a lot of Canadian timber, eliminating a large source of competition for U.S. lumber sellers and further correcting the mismatch between supply and demand.
“We are getting closer, just not quite there yet,” he says.
Even if returns do stay lower for longer, Johnson points to other benefits of the asset class, in particular its use as a diversifying asset and hedge against inflation. It is primarily for these reasons that NZ Super allocates roughly 5 percent of its portfolio to forestlands.
“It doesn’t go up and down the same as the S&P 500; it does behave independently of the equity markets,” Woods says. “We’re quite happy to sit where we are with the timberland assets we got.”