The Great Capital Mis-Match in Forestry 

Why differing investor and investee needs are restricting capital deployment into the forest 

There is a mismatch between available investment capital and the forest investment opportunities seeking capital.  

On the capital side, issues such as risk tolerance, return expectations (and cashflow timing), preferred or familiar investment structures are resulting in investment vehicles that are not fit for purpose with the opportunities in greatest need of capital on the ground.  

On the asset side, the long-time horizons of forestry – with front-loaded capital requirements coupled with long-term cashflow generation (at least in early-stage afforestation or reforestation projects) does not bode well for a dynamic transaction environment in forest investment. 

In this week’s article, this mismatch will be unpacked, while identifying some enablers to spur more transactions and get much needed forest investment capital to the ground. 

Challenge 1. The Desired Timberland Universe is Small 

According to McKinsey (2022), the global timberland universe in 2021 (based on privately owned asset value) was USD 1.2 Trillion, this compared to agriculture, which was USD 7.3 Trillion, or 6 times the size of timberland. 

Why does this create a mismatch? Well, for starters – the size, might very well be a result of the mismatch itself. 

Many institutional investors prefer forest investments of the following characteristics: 

• Strong timberland fundamentals,  

• Managed with the highest sustainability principles,  

• Can provide interim cashflows (ie. mature forest assets), and  

• Where they possess fee-simple ownership over the assets.  

This immediately restricts the investable universe. As more investors enter the natural capital space and seek forest assets – assets with these characteristics provide the most risk reduction and are the most in demand. What this means is the same, or an increasing capital pool chasing the same assets.  

The mismatch here is that the majority of significant forest investment capital is seeking a limited supply of core timberland assets (where the heavy lifting capital requirement burden of immature assets has long passed). 

Challenge 2. Immature Forest Assets are not Desired 

Though of course this is a gross generalization, the challenge remains that both experienced and inexperienced forest investors are (mostly) not attracted to the forest assets that need the most capital. If you consider the progression of a forest asset, it will commonly follow the same trajectory (assuming processing is not vertically integrated): 

1. Enabling environment 

2. Sourcing planting materials 

3. Infrastructure development 

4. Site preparation and planting 

5. Ongoing silviculture (pruning, thinning) 

6. Harvesting 

7. Log sales 

Mature assets will rotate between stages 4-7, and operating costs can largely be funded by log sales revenues. 

Immature assets have the disadvantage of requiring several sunk costs at the beginning of the acquisition associated with land/tenure securitization, initial stakeholder engagement, soil assessments, sourcing planting materials, trials, etc. Roads may need to be built and other basic business infrastructure, such as nursery construction, office space, purchase of vehicles and machinery, etc. need to be accounted for. Not only are these costs a factor, but the assets are that much further away from cash generation, and the risks that something will go wrong prior to that are higher than in mature assets, that have already proven themselves. 

The mismatch here is that if you look at the forest sector broadly and consider “what the forest needs” (and what we want them for), we need to bring more forests into sustainable forest management – that is forests that combine both protection and production values. The forest needs more of these immature assets to be capitalized, but the gross majority of private capital available doesn’t like the characteristics (compared to mature assets). 

So how can we enable more transactions in forest investment, and more capital deployment on the ground? 

Forest Investment Enabler 1: Insurance 

I read an interesting report recently from The Boston Consulting Group (BCG, 2024). The whitepaper looked at insurance as a necessary financial instrument for supporting the climate transition.  

“Nothing gets financed ordinarily without insurance, but the financing of the largest capital expenditure of all time, the protection of nature-based solutions and expansion of new carbon and biodiversity credit markets, are being attempted largely without mobilising the power of insurance.” 

Not only can insurance give investors more piece of mind with the increasing threats of both real and perceived risks associated with climatic events, insurance serves as a crucial nexus for governing and managing risk. A real example of this in insuring forest assets – where assets will only be insurable (or premiums affordable) if the forest manager can demonstrate it is actively managing to prevent wildfire. You can listen to a podcast episode I recently recorded with Gordon Steward of Dual on this topic. 

In short, insurance can help investors become more comfortable with the risk of investing in forests, especially at the early stage. 

Forest Investment Enabler 2: Carbon Markets 

Though early stage forest investments might not be the most desirable for the timberland investor I described earlier, they are optimal for carbon credit buyers or investors interested in the climate impacts associated with the emission removal potential of afforestation and reforestation projects.  

That said, carbon credit markets remain a dynamic (uncertain), and short-term solution for the climate transition. Long term timberland fundamentals are still critical for maintaining a long-term sustainable supply of wood products and sustainably managed forests. We need a blend of capital originating from the carbon markets, that can lower the barrier to entry, or the cost of capital for more forest investors to participate in early-stage projects. I recommend that you read the paper: Natural Climate Solutions for the Voluntary Carbon Market: An Investor Guide for Companies and Financial Institutions, produced by the Natural Climate Solutions Alliance (2024). 

Forest Investment Enabler 3: Impact 

Building on the integration of carbon markets is impact. Building a tangible impact case into your forest business or investment strategy will stand a better chance of attracting carbon investors (as high integrity is key, and issues such as biodiversity and community benefit sharing are key components of the integrity piece). Not only will it help to attract carbon capital, but more generally, investors that are seeking sustainable investment opportunities that align with various regulations and voluntary standards for best practices.