By Campbell Global’s John Gilleland, managing director and chief executive officer, and Dave Rumker, managing director and chief investment officer. (Campbell Global is part of J.P. Morgan Asset Management.)
In brief
- Demand for natural capital assets is expected to grow, with forestland investments providing a leading role in supporting numerous investor objectives including carbon removal, sustainable investing and improving biodiversity, while generating long-term strong risk-adjusted returns.
- Cash yields and value increases in 2023 for timberland assets are expected to continue, supported by improving housing and lumber demand, particularly in 2024 H2 and into 2025, in response to improving affordability, as interest rates are expected to gradually decline over the next 18 months.
Timberland in focus
The timberland asset class finished 2022 with double digit positive returns uncorrelated to other major asset classes. Subsequently, global demand for sawtimber softened in 2023, in large part due to soft economic activity in China as well as rising US interest rates and related affordability challenges.
Despite the latter, US housing starts in 2023 were higher than most years over the last decade. The underbuilt supply of homes in the US and other areas of the developed world, combined with historically low levels of existing homes on the market, led to increased US demand for new home construction. 2023 asset returns exceeded 9%. We anticipate rising log prices and yields in 2025 and beyond.
Carbon markets are also continuing to evolve, with growing investor interest and investment in carbon offsets and projects – by both investors and users of offsets. Forests provide a material portion of offsets generated in the voluntary carbon markets with carbon prices across markets expected to have strong support in the coming years.1
Global CLT consumption (construction only)
Working forests also provide investors with other tangible ESG-related opportunities that can come from natural capital investments, ranging from maintaining and improving biodiversity on landscapes, to water protection, to providing living-wage jobs in rural communities.
New home construction, as well as repair and remodelling, together comprise about 70% of lumber demand. New home construction softened in much of 2023, but not as much as was expected. Pent-up US housing demand among younger homebuyers should continue to spur steady demand through 2025 and beyond, with increased demand in subsequent years2 as home prices and mortgage rates continue to moderate.
Longer term, a rising proportion of single-family homes (rather than multi-family units) being built should further boost lumber demand per unit.3 Acceptance of engineered wood products, such as cross-laminated timber (CLT), in medium-rise construction globally has increased lumber demand, with projections continuing to increase significantly.
Global sawtimber supply constraints moderated in 2023 with slowing demand; however, long-term supply is expected to be increasingly constrained relative to traditional demand drivers. In addition, traditional supply constraints are expected to be further restricted as timberlands are sought for carbon sequestration, increasingly limiting investment opportunities and likely leading to capital appreciation in many regions of the world.
Softwood lumber consumption by major end-use
Investing in a well-diversified, global timberland portfolio should continue to be attractive as a portfolio diversifier, an inflation hedge, a natural climate solution and an investment with nature-based ESG attributes, while also generating income through the sale of wood products.
As demonstrated in 2022 and early 2023, strong demand and improved prices lifted income returns. Future returns are expected to benefit further from tight log supply in the US Pacific Northwest, Australia and Chile and from increasing processing facility investment in the US South.
Higher log values and tight log markets should help accelerate capital appreciation and support current market discount rates, particularly in tight log market areas. Carbon monetisation, biodiversity, water, recreation and other important attributes can provide an additional overlay of revenue potential.
Looking forward, potential risks include an unanticipated economic slowdown in 2024 that could materially dampen housing demand in response to government policy measures that slow economic growth. Current housing affordability will remain a risk until interest rates moderate.
Based on the FEA’s projections illustrated in the chart below, US lumber consumption and log demand is expected to expand once again in the next 12-18 months, driven by pent-up demand for new home construction as well as repair and remodelling demand, while existing homes available for sale will continue to be constrained.
1 The price of carbon varies globally, set either by governments that tax carbon or markets through emissions trading systems – both currently a varied patchwork. The “social cost of carbon” (currently set by the U.S. administration at USD 15 per ton for analysis and planning purposes) quantifies damages to health, property, agriculture, ecosystems, loss of life and more; some studies suggest the eventual price could be eight times higher. Dr. Sarah Kapnick, “The global carbon market: How offsets, regulations and new standards may catalyze lower emissions and create new opportunities,” J.P. Morgan Asset management, October 14, 2021.
2 Pent-up demand is approaching four million units due to a decade of underbuilding plus annual housing demand of about 1.5 million housing units; the industry is also seeing the long-anticipated emergence of homebuyers aged 25 to 40 purchasing their first homes.
3David B. Keever and Joe Elling, “Wood products and other building materials used in new residential construction in the United States, with comparison to previous studies,” APA- The Engineered Wood Association, 2015 and “Analysis and Forecast of the Main End-use Sectors for Wood Products in North America,” Forest Economic Advisors, 2021.
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