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Why is it a good idea to invest in wood?
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Why is it a good idea to invest in wood?

Long term timber price trends and climate change mitigation, are some of the reasons why timber can be an attractive investment.
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22 FEB, 2023

By Constanza Ramos

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"Historically, timber as an asset class has been paid little attention by institutional investors in comparison to, for example, real estate and infrastructure, especially in Europe. This is now changing as market dynamics, the environmental imperative and the macro risk environment all combine to refocus investor attention", the Aquila Capital report notes, detailing the reasons why timber can be an attractive asset to invest in.

Although one might believe otherwise, wood can contribute to climate change mitigation. It can also offer strong, long-term timber price trends, an upside potential through asset optimization, and portfolio diversification.

Peter Schnellhammer, Investment Research Analyst, Dr. Johannes Baare, Head Land Use and Carbon Forestry and Edward Daniels, Team Head Forestry at Aquila Capital, tell us more below.

Strong, long-term timber price trend

Aquila Capital sees one major demand driver as the decarbonization of the construction sector with the industry increasingly using timber as a substitute for concrete and steel, where possible. "In conjunction with increasing urbanization resulting from a growing world population, timber demand is expected to increase, strongly supporting timber prices", points out the report.

The company explains that mid to short-term volatility in certain markets "can be mitigated through the conclusion of timber supply or fixed price agreements". Specifically, they detail that an international timber portfolio "allows the manager the flexibility to slow or stop harvesting operations in areas with weaker timber prices, and to take advantage of stronger timber prices in others. The unique advantage of timber is that there is no need to harvest in times of lower timber price, allowing the trees to continue to grow in volume and value “on the stump”, preserving and increasing the capital value of the timber investment".

Climate change mitigation

Across all age classes, one hectare (ha) of forest in Central Europe binds approximately 12 tons of CO2 annually through photosynthesis in below and above-ground biomass. "The total carbon sequestration ability is dependent on a variety of factors such as tree species, maturity, micro-climate, as well as nutrient and water availability", clarifies the report.

In this context, sustainably managed forests under a suitable silvicultural regime will perform better in terms of their carbon sequestration function as compared to unmanaged forests. This is due to the fact that forest management entails routinely harvesting mature trees, which tend to bind less carbon dioxide from a certain age.

"Therefore, investments in sustainably managed forests can play a vital role in combatting climate change. Structured in accordance with the applicable legal frameworks, timber investments may also contribute to achieving an investor’s individual net zero goals in the context of disclosure to markets and stakeholders".

Upside potential through asset optimization

The report explains that changes to the silvicultural regime, the amalgamation of smaller assets in larger portfolios, improvements to supporting infrastructure, and improvements within the applicable regulatory framework, "tend to have a positive effect on the value of the relevant forestry asset or portfolio".

In addition, Aquila Capital points out that managers of timber investments "unlock income streams from forestry-related and ancillary sources, such as carbon sequestration and renewable energy opportunities".

"The generation and sale of carbon units in the compliance and/or voluntary market is nowadays the most prominent example for the monetization of forest-related ecosystem functions. The development of, for example, wind farms in suitable forest areas also adds value to an existing asset", highlights the company.

Portfolio diversification

The authors state that while the prices of timber properties are directly dependent upon the forecasted cash flows and changes in the market discount rate, "the returns are not only driven by wood prices as a function of supply and demand, but also by biological growth". 

Biological growth as a driver of yield, in turn, is completely independent of financial markets, they say. Hence, decoupled from the economic fundamentals underlying financial assets. "Forestry assets provide diversification and value protection in mixed portfolios as the future yield increases through biological growth even in times of uncertainty and volatility", they add. 

Moreover, they indicate that apart from limited correlation with the prices of financial assets, the risk profile of forest investments "may further be optimized through spatial, temporal, product, and market diversification".

"Managers of forestry investments with a deep understanding of the applicable silvicultural regime and functioning of the global timber markets can build portfolios comprising various jurisdictions on different continents, age class distributions as well as a suitable mix of tree species", conclude.

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