Timberland investing and the promise of carbon markets

Key takeaways

  • Timberland has long been hailed by institutional investors for its merits as a portfolio diversifier with attractive risk/return characteristics: It can offer dependable cash yields, inflation protection, and low correlations with mainstream financial markets.
  • Forests represent the lungs of the planet, and a growing and increasingly broader base of demand is likely to strengthen forest property values as the emergence of voluntary carbon offset markets reshapes timberland market dynamics.
  • Rising carbon prices will open new strategic opportunities for timberland investors, and we believe those opportunities might not be fully appreciated by the market at this time.

Timberland has long been recognized by institutional investors for its merits as a portfolio diversifier with attractive risk/return characteristics. The recent growth in the use of carbon offsets by major corporations as they transition toward carbon neutrality should open new carbon-focused opportunities for timberland investment managers, allowing them to augment and diversify income revenue beyond the sale of unprocessed logs and other traditional uses of forest properties. The increasingly inevitable policy response from governments around the world to counter climate change is likely to include nature-based solutions, with an expanded role for carbon capture and storage by forests, supporting property values for timberland investors.  

Timberland has a solidly established role for institutional investors

Institutional investment in timberland grew at a healthy pace over the past three decades, with particularly robust growth in the 1990s and early 2000s. Timberland assets under management reported to the NCREIF U.S. Timberland Index, increased from $2 billion in 1995 to $24 billion by 2020.¹ Timberland is attractive to investors because of its favorable history of diversification benefits and return characteristics, and is well accepted as a component in institutional portfolios.

Correlations with U.S. timberland, 2000 to 2019. This chart shows that timberland returns have had low or negative correlations with returns of financial assets.
“Timberland is attractive to investors because of its favorable history of diversification benefits and return characteristics, and is well accepted as a component of institutional portfolios.”

Timberland’s record of delivering competitive and consistent cash yields, protection in periods of moderate and high inflation, and long-term capital appreciation has provided a strong incentive for investors to include this real asset in their portfolios.²

U.S. timberland and U.S. Treasury annualized returns (%), 2000 to 2019. This chart shows that timberland has offered dependable cash yields, capital appreciation, and limited drawdowns over time.

Revenue sources are no longer limited to the sale of unprocessed logs

The principal source of timberland cash returns is the sale of unprocessed logs for a variety of end uses, including lumber, wood panels, pulp, paper, paperboard, tissue, and woody-biomass energy. These timber-specific revenue streams have generally accounted for roughly 90% of the cash yield associated with a timberland property.³ Managers of institutional timberland have steadily moved to more fully unlock and monetize other commercial and environmental, social, and governance values embedded in their timberland properties. Additional sources of property revenue that have been developed include:

  • Property leasing for recreational uses
  • Installation of wind farms and solar energy projects
  • Mining or drilling for minerals, oil, and gas
  • Grazing rights
  • Conservation easements development rights and protection of sensitive landscapes or wildlife
  • Ecosystem services
  • Sale of carbon credits

The potential of a particular timberland property to harbor any one of these nontimber revenue streams depends on the site-specific elements of the forest and is increasingly fully recognized by the market and incorporated into property valuations and appraisals.

The world’s forests represent the lungs of the planet

The ability of forests to capture and store carbon dioxide (CO2) is broadly recognized as one of the most effective and cost-efficient mechanisms available to mitigate climate change. The operations and science of measuring, tracking, and certifying the volume of CO2 captured and stored by a particular forest is well established, and forest carbon projects have been extensively used to offset greenhouse gas (GHG) emissions under a number of government programs attempting to reduce the concentration of GHGs in the atmosphere. A number of Emission Trading Systems (ETS) around the world include the use of forestry offsets, including systems in California, Quebec, the Northeastern United States (Regional Greenhouse Gas Initiative, or RGGI), Tokyo, Kazakhstan, New Zealand, the European Union, Switzerland, Korea, and China.⁴

The widespread acceptance of forest carbon offset credits in these government-mandated programs has fostered the growth and development of active markets for the trading of carbon stored in forests, and a path for timberland owners to capture value from the carbon capture and storage capabilities of their forests.

“The ability of forests to capture and store carbon dioxide (CO2) is broadly recognized as one of the most effective and cost-efficient mechanisms available to mitigate climate change.”

The first regulatory ETS, launched in the European Union in 2005, focused on the key GHG emitting sectors in the economy, power generation, industry, and domestic aviation.⁵ In the United States, California’s Global Warming Solutions Act of 2006 set the stage for statewide GHG emission limits. Mandated compliance with the law began in 2013. The California GHG emissions program covers power generators, industry, transportation, and buildings, which accounted for 85% of the state’s GHG emissions in 2019. The Regional Green House Gas Initiative (RGGI), a mandatory cap-and-trade system, covering COemissions from power plants in the Northeast and mid-Atlantic states began in 2009. Since the mid-2000s, additional carbon markets in other states, provinces, and countries around the globe have been created, but the European Union and North America (California, RGGI, and Quebec) remain the largest ETSs, and together accounted for 98% of total global carbon transactions in 2019.⁶ California’s regulatory cap-and-trade program has perhaps been the most influential in defining standards for U.S. forestry offset projects and providing a marketplace for transactions. The California cap-and-trade program defines one allowance, or carbon credit, as equivalent to one ton of carbon emissions, a GHG reduction of one metric ton of CO2.

A GHG project is a specific activity or set of activities intended to reduce GHG emissions, increase the storage of carbon, or enhance GHG removals from the atmosphere.⁷

A GHG project earns “carbon offset” status if the GHG reductions or removals generated are used to compensate for—or, offset—GHG emissions occurring elsewhere.⁸

Projects that meet the qualifying standards are issued emission reduction or removal credits.

Under the California Air Resources Board (CARB) compliance offset program, offsets are restricted to U.S. projects in the following six categories:⁹

  • Ozone depleting substances (ODS)
  • Livestock
  • U.S. forests
  • Urban forests
  • Mine methane control
  • Rice cultivation

U.S. forests have accounted for over 80% of the offset credits issued since 2013.¹⁰

This infographic shows that there are close to 2000 U.S. CARB compliant forest projects, 90% of which are classified as improved forest management projects; U.S. forests have accounted for over 80% of offset credits issued since 2013.

CARB’s Compliance Offset Program requires U.S. forest projects to meet one of the following forest management objectives: 

  • Reforestation: the restoration of tree cover on land that has no, or minimal, tree cover
  • Improved forest management: activities that increase carbon stocks on forested land relative to baseline levels of carbon stocks
  • Avoided conversion: specific actions that prevent the conversion of privately owned forestland to a nonforest land use by dedicating the land to continuous forest cover through a conservation easement or transfer to public ownership

Currently, there are close to 200 U.S. CARB compliant forest projects. An overwhelming 90% of the forest projects registered are classified as improved forest management projects.¹¹

Voluntary carbon markets—a potential boost to forestland demand

Legislated government mandates to reduce GHG emissions, such as those in the European Union and California, were key factors in establishing carbon offset markets, but recent momentum in carbon markets, reflected in gains in carbon offset prices, has been driven by broader crossborder initiatives. The Paris Agreement reached in 2015 set ambitious targets for reducing GHG emissions and outlined possible paths to achieve compliance. The Paris Agreement includes the use of internationally sourced offset credits to meet targeted reductions in GHG emissions. Negotiations on the implementation mechanisms for the Paris Agreement are scheduled for 2020.

Another major nongovernmental program with the potential to boost demand for carbon offset credits is the Carbon Offsetting Reduction Scheme for International Aviation (CORSIA). 

Launched in 2016 by the International Civil Aviation Organization, CORSIA is a UN specialized agency covering international civil aviation. CORSIA aims to offset future emissions from international flights that are above the 2020 emission levels. The volume of carbon offsets expected to be needed under CORSIA would more than double the current volume of voluntary carbon offsets, suggesting the potentially significant scale of the long-term impact from voluntary carbon reduction programs. The first compliance phase (2021 to 2026) of CORSIA is voluntary, and a second phase (2027 to 2035) is mandatory. Which offsets and which programs will be eligible for use under CORSIA remains under debate. 

With a growing public awareness and sensitivity to climate change, numerous major corporations, organizations, and nonprofit entities in the United States and globally have voluntarily announced commitments and plans to reduce their carbon footprints. Major firms that have communicated bold ambitions concerning decarbonization, include British Airways parent IAG, Disney, EasyJet, Google parent Alphabet, Microsoft, and Shell.¹² The funding of carbon offset projects and the purchase of carbon credits are recognized avenues to achieve these voluntary carbon goals. 

Since 2008, over 130 million voluntary offset credits have been issued and about 40 million have been retired.¹³ The Climate Action Reserve provides protocols, guidelines, and tools to support the voluntary offset market, currently with 19 protocols adopted for use in the United States and Mexico, and over 400 offset projects registered in over 40 states.     

Participants in the voluntary carbon markets aren’t bound to comply with the legislative requirements specified by California or the European Union, but most of these organizations want their carbon offset projects to meet generally accepted standards and protocols that will:

  • Certify and validate their carbon reduction efforts
  • Align their efforts with broader climate change mitigation
  • Allow for trading to facilitate the management of their portfolios of carbon credits 

The operational infrastructure built to support California’s legislated effort to reduce carbon emissions provides an institutional template to trade carbon credits that is facilitating the more recent growth of the voluntary carbon offset market.

A public sentiment shift may open doors for timberland investors

Increasing attention on implementable solutions to mitigate climate change are setting the stage for policy responses to be developed in the mid-2020s supporting reafforestation, stronger enforcement of zero deforestation, and expansion of bioenergy crops. In this increasingly climate change-sensitive environment, the price of carbon has already moved higher. The price per ton of emission allowances within compliance markets in the European Union, New Zealand, and California have trended upward from a level of less than $15 per ton in the mid-2010s to between $15 and $30 per ton by early 2020.   

Price (US$) per ton of emission allowances within compliance markets, 2012 to 2020. This chart shows that new tiers of demand for carbon offsets have moved carbon prices higher over recent years.

In a scenario analysis commissioned by Principles for Responsible Investing (PRI) and performed by a collaboration between PRI, Vivid Economics, and Energy Transition Advisors, carbon pricing is projected to trend up to the US$40 to $80/tCO2 range by 2030, triggering significant changes in land use and opening opportunities to invest in nature-based climate solutions such as timberland. The Inevitable Policy Response, which models these expected policy developments in a Forecast Policy Scenario, results in a cessation of net forest cover loss by 2030, and a total of 350 Mha of afforestation and reforestation globally by 2050.¹⁴

Changing role of carbon capture and storage in timberland investing

Higher carbon prices would provide an added market dimension to timberland operations and offer greater optionality for timberland owners, particularly on the less productive or higher cost areas of their properties.

Higher carbon prices and expanded demand for forest carbon projects and forest offset credits will involve a paradigm shift in timberland investments. The current emphasis on commercial, production-oriented plantation forestry could broaden into new strategies focused on achieving the most cost-efficient capture and storage of carbon to meet the environmental goals of new tiers of capital focused on impact investment objectives. This emerging class of carbon-focused timber investment will expand timberland’s investable universe by pushing the boundaries of acceptable investment-grade forest projects geographic location, and the structures of the investment. 

“Higher carbon pries and expanded demand for forest carbon projects and forest offset credits will involve a paradigm shift in timberland investments.”




NCREIF.org, 2020. 2 htrg.com/wp-content/uploads/sites/2/HTI-Q2-2019-final.pdf, HNRG, September 2019, and htrg.com/wp-content/uploads/sites/2/HTI_Q3_2013_A_Historical_Perspective_on_the_Relationship_between_Timberland_Returns_and_Inflation_.pdf, HNRG, third quarter, 2013. 3 Hancock Natural Resource Group, 2020. 4 ETS Brief #7, International Carbon Action Partnership, December 2019. 5 icapcarbonaction.com/en/ets-map, 2020. 6 Carbon Pulse, Hancock Natural Resource Group, 2020. 7 World Resources Institute, World Business Council for Sustainable Development, 2005. 8 Offset Quality Initiative, 2008. 9 arb.ca.gov/cc/capandtrade/offsets/offsets.htm, 2020. 10 California Air Resources Board, December 2019. 11 California Air Resources Board, Hancock Natural Resource Group, 2020. 12 Reuters, October 2019. 13 climateactionreserve.org/how/projects/, October 2019. 14 unpri.org/inevitable-policy-response/what-is-the-inevitable-policy-response/4787.article, 2020.


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Thomas G. Sarno

Thomas G. Sarno, 

Global Head of Timber Investments

Manulife Investment Management

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Keith A. Balter

Keith A. Balter, 

Senior Advisor, Strategic Initiatives, Timberland and Agriculture

Manulife Investment Management

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Mary Ellen Aronow

Mary Ellen Aronow, 

Director of Forest Economics, Timberland

Manulife Investment Management

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