The Benefits of Timberland in a Real Estate Portfolio

Transcription

1 Hancock Hancock Timber Resource Group Timberland Investor First Quarter 20 The Benefits of Timberland in a Real Estate Portfolio Despite the unique risk and return characteristics of timberland, most investors include it with either their private equity or real estate portfolios. Of the two, we think including it with the latter is generally more appropriate. But doing so raises the question of how timberland affects the risk and return of the overall real estate portfolio. Because of timberland s investment characteristics, it can substantially reduce the volatility of a broad, mixed-asset real estate portfolio and at the same time materially increase returns. Three kinds of evidence demonstrate the positive effects of adding timberland to a real estate portfolio. First, we simply compare the historical performance of private timberland equity with both private and public commercial real estate equity. Second, we calculate historical returns for a real estate portfolio with varying amounts of timberland. Finally, we use expectations of future performance to estimate risk-efficient frontiers for real estate portfolios with and without a timberland component. Historical Returns Historical return data come from the standard sources: the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index (NPI) for unleveraged private equity real estate; the National Association of Real Estate Investment Trusts (NAREIT) Equity REIT Index for public equity real estate; and the NCREIF Timberland Index for unleveraged private timberland equity. The analysis period corresponds to the availability of the NCREIF timberland data.all returns are nominal. Figure A plots calendar-year returns for the three asset classes. Casual observation clearly reveals the consistently positive returns to timberland throughout the period unlike both the NPI and the NAREIT Index.The NAREIT Index shows the greatest variation in returns, ranging from a high of 35.5 percent in 19 to a low of percent in 18. Figure A. Historical Annual Returns return (%/year) Source: NCREIF & NAREIT The table on page 2 shows the level, volatility and Sharpe ratios for each asset s returns.annualized returns to timberland have been highest throughout the 13-year period at 20.1 percent. Public real estate has outperformed private real estate, yet with much greater volatility. Comparisons of Sharpe ratios (a measure of return premium per unit of risk) show continued on page 2 Timberland Index NAREIT Index NPI Hancock Timber Resource Group High Street, Boston, MA

2 The Benefits of Timberland in a Real Estate Portfolio continued returns to timberland have been highest on a risk-adjusted basis as well. Annual Returns for Timberland and Commercial Real Estate, Annualized Standard Sharpe Return Deviation Ratio Timberland Private Real Estate Public Real Estate Note: For Sharpe ratio calculations, we used 5.3% as the riskfree rate, corresponding to the 30-day Treasury bond rate over the 13-year period. Casual observation of Figure A also suggests that timberland returns have not tracked returns for commercial real estate. Indeed, timberland returns were relatively high when returns for private equity real estate bottomed in the early 10s, and have been relatively low as private equity real estate performance has recovered during the late 10s. The table below presents a correlation matrix for returns to timberland and commercial real estate.timberland had a negative correlation with private real estate and a low positive correlation with public real estate. Interestingly, private and public real estate were negatively correlated.this result is consistent with discussions in the real estate literature, which posit that public equity returns lead private returns and are influenced by the stock market. Correlation of Returns for Timberland and Commercial Real Estate, Private Public Timberland Real Estate Real Estate Timberland 1 Private Real Estate Public Real Estate Adding Timberland to a Real Estate Portfolio These historical results suggest that a real estate portfolio with a timber component would have generated both higher and more stable returns than a real estate portfolio without timberland. To quantify these effects, we first modeled a real estate portfolio without timberland, weighted percent to private real estate and 10 Figure B. Risk and Return with Incremental Additions of Timberland to a Real Estate Portfolio % return % Timberland % Timberland 20% Timberland 15% Timberland 10% Timberland percent to public real estate. Using historical returns and standard deviations, our hypothetical real estate portfolio returned 6.5 percent with a standard deviation of 5.5 percent. Figure B. shows the increase in return and reduction in risk with the addition of timberland to the portfolio.we included timberland in increments of 5 percent up to a maximum of 30 percent, while proportionally decreasing both the private and public real estate equity holdings. As little as 5 percent timberland added 68 basis points of return to the overall portfolio, while at the same time lowering volatility.at 30 percent timberland, we were able to add 408 basis points and decrease volatility by almost 30 percent. Risk-Efficient Frontiers We also examined the consequences of adding timberland to a real estate portfolio by creating risk efficient frontiers with and without timberland. The efficient frontier shows the risk that must be undertaken to achieve each desired level of return. Portfolio allocations below this frontier are inferior, where greater returns could be achieved without incurring additional risk. We used expected nominal returns of 11 percent for public equity real estate and 10 percent for private equity real estate.timberland returns were set at an expected rate of 11 percent. Standard deviations and correlations were based on historical data for all three assets % Timberland 0% Timberland % standard deviation The two frontiers are traced in Figure C on page 6. Our results are further evidence that the addition of timberland to a portfolio of private and public real estate can substantially reduce its volatility. Consider a target 2 continued on back cover Hancock Timberland Investor First Quarter 20

3 Quarterly Average Regional Composite Prices: Softwood Sawtimber Stumpage US$ per MBF $1,0 $8 $6 $4 Pacific Northwest Export Pacific Northwest Domestic New Zealand Export Source: Log Lines, Timber Mart-, New Zealand Ministry of Forestry and HTRG analysis Figure 1. Regional Softwood Sawtimber Stumpage Prices Sawtimber prices remained relatively stable during the first quarter of 20. Strong U.S. lumber markets supported stumpage prices in the, Pacific Northwest and. Export log prices in the Pacific Northwest were up slightly due to declining log inventories in Japan. U.S. lumber markets have softened considerably since the first quarter, which should exert downward pressure on U.S. sawtimber prices during the remainder of the year. $2 Note that we have re-estimated our New Zealand export log price series to now include a broader mix of A, J and K sort export logs. Quarterly Average Regional Composite Prices: Softwood Pulpwood Stumpage Per Ton $40 $35 $30 $25 $20 $15 Pacific Northwest Figure 2. Regional Softwood Pulpwood Stumpage Prices Pulpwood prices in the U.S. and dropped from last quarter s levels despite stronger global pulp and paper markets. Dry weather in the boosted pulpwood supplies and kept prices down. Additionally, recent reductions in pulp and paper capacity have been hindering the transfer of higher pulp and paper prices down to the stump. $10 $5 Source: Log Lines, Timber Mart- and HTRG analysis Regional Timberland Values Per Acre $2,5 $2,0 $1,5 Pacific Northwest Figure 3. Timberland Prices First-quarter 20 timberland values showed little change over last quarter. The increase in southern timberland values can be largely attributed to changes in the sample of properties in the NCREIF database rather than a shift in market conditions. $1,0 Note that we have re-estimated our series of timberland values in the to correct for the inclusion of what we believe to be an anomalous property in the NCREIF database during 18 Q4 through 19 Q3. $5 Source: NCREIF Hancock Timberland Investor First Quarter 20 3

4 Timberland Enterprise Value per ern Equivalent Acre Per Acre $1,2 $1,0 $8 Timberland Enterprise Value/ ern Equivalent Acre NCREIF ern Timberland Index Figure 4. Timberland Enterprise Value The gap between private and public timberland values widened during the first quarter of 20. This suggests that there continues to be an opportunity to create value by transferring timberland from public to private ownership. $6 $4 $2 Source: NCREIF and HTRG analysis EBITDDA Multiples for Privately Traded Timberland Figure 5. Timberland Price to Earnings Ratio Timberland EBITDDA multiples were mixed first quarter with the trending upward, the trending downward, and the Pacific Northwest remaining relatively unchanged. Note that we have also re-estimated the EBITDDA multiple for the during the period 18 Q4 through 19 Q Pacific Northwest Source: NCREIF and HTRG analysis Timberland Investment Performance Indexed: 10(1)= NCREIF Pacific Northwest NCREIF All-Region S&P 5 Index NCREIF NCREIF S&P Forest Products Index T-Bill Figure 6. Timberland Returns (10-20) Private timberland returns were up over last quarter in all three regions of the U.S.The S&P Forest Products Index, on the other hand, dropped over 18 percent during the first quarter. Weakening primary and secondary forest product markets over the quarter drove returns down for the public companies included in the Index. Conversely, moderate gains realized in stumpage and log markets fueled private timberland returns. 1.0 Source: NCREIF, Ibbotson and HTRG analysis 0 4 Hancock Timberland Investor First Quarter 20

5 Timberland Investment Performance Indexed: 14(1)=1 2.5 Securitized Timberland (MLP/REIT) NCREIF All-Region S&P Forest Products Index 2.0 Securitized Timberland (Total) 1.5 Figure 7. Timberland Returns (14-20) The effects of recent price decreases in building products can be seen quite clearly in the returns charted here. Returns to timberland-intensive public companies and returns to private timberland equity, as measured by the NCREIF Timberland Index, posted gains during the first quarter. In contrast, the S&P Forest Products Index, measuring returns to integrated companies, lost all of last quarter s gain to end the quarter below levels seen during third-quarter Source: NCREIF, Ibbotson and HTRG analysis 0.5 Securitized Timberland Performance Indexed: 14(1)=1 160 Deltic Crown Pacific Plum Creek 140 U.S. Timberlands The Timber Company Index Figure 8. Hancock Securitized Timber Index Declining primary and secondary forest product prices were the major catalyst for the drop in the Hancock Securitized Timber Index during the first quarter.the composite value of all companies included in the Index was down, yet small increases or marginal decreases by a few of the companies in the Index over the quarter helped cushion the fall. 60 Source: HTRG analysis 40 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ Hancock Timberland Investor First Quarter 20 5

6 Figure C. Risk Efficient Frontier annual nominal return (%/year) Real Estate With Timberland 33% Timberland 50% Timberland 81% Timberland return of 10.5 percent.without timberland, the risk-efficient portfolio has a standard deviation of 7.9 percent.with timberland (38%), the standard deviation decreases to 4.2 Real Estate Without Timberland standard deviation (%/year) percent and the Sharpe ratio increases 86.4 percent to Summary and Conclusions Three conclusions appear to be warranted. First, since 17 timberland has generated higher returns than real estate, timberland returns have been relatively stable, and timberland returns have been poorly correlated with both public and private equity real estate. Second, institutional investors that included timberland in their real estate portfolio over the 13-year period had higher returns with lower levels of risk.and last, because of the negative correlation between private equity timberland and private equity real estate, timberland could improve the investment performance of a mixed-asset real estate portfolio even with lower expected rates of return for timberland and higher expected rates of return for real estate. Our results are based on domestic timberland investments alone, and the further diversification and additional returns associated with a global timberland portfolio would further improve portfolio performance. A 19 HTRG-commissioned report by Apogee Associates, LLC provides more detail on this topic. Please contact us to request a copy. Research Team Clark S. Binkley, Ph.D. Chief Investment Officer cbinkley@hnrg.com Courtland L. Washburn, Ph.D. Director of Economic Research & Investment Strategy cwashburn@hnrg.com Mary Ellen Aronow Forest Economist maronow@hnrg.com Timo Fritzinger Financial Analyst tfritzinger@hnrg.com Figure 1. The composite price for southern sawtimber is based on quarterly average Timber Mart- published prices for pine sawtimber and chip-n-saw stumpage. Pacific Northwest prices are derived from quarterly average Log Lines published prices for whitewoods and Douglas-fir with internal analysis of logging costs for stumpage calculations. New Zealand export prices are based on New Zealand Ministry of Forestry quarterly average published prices for Radiata unpruned A, J and K sort export logs with internal analysis of logging costs for stumpage calculations. sawtimber prices are calculated from internal analysis. Figure 2. Pulpwood composite prices are derived from quarterly average Timber Mart- published prices for southern pine pulp wood stumpage, Log Lines published whitewood and Douglas-fir pulp logs with internal analysis of logging costs for the Pacific Northwest, and HTRG analysis of Spruce/Fir pulpwood in the. Figure 3. Regional NCREIF timberland market value per acre is derived by dividing the total regional market value at quarter end by the number of acres reported in that region. Due to the small sample of property in the Pacific Northwest in 17 and 17 Q2, these values were back cast from 17 Q3 with quarter-end appreciation returns. Market values for timberland were re-estimated for the period 18Q4 through 19Q3 to adjust for what we believe to be an anomalous property included in the NCREIF database during those quarters. Figure 4. Timberland Enterprise Value per southern Equivalent Acre (TEV/SEA) for five timber-intensive publicly traded companies compared to southern timberland values per acre calculated from the NCREIF database. TEV is a quarterly estimate based on total enterprise value (total market equity + book value debt) less estimated value of processing facilities, other non-timber assets and non-enterprise working capital. SEA uses regional NCREIF $/acre values to translate a company s timberland holdings in various regions to the area of southern timberland that would have an equivalent market value. Figure 5. EBITDDA multiples are calculated using NCREIF timberland value per acre at quarter end divided by a trailing four-quarter average NCREIF net income per acre. Figure 6. Total quarter-end returns to timberland based on the NCREIF database. returns prior to 14 are based on the John Hancock Timber Index. Additional adjustments were made to return calculations in the for the period 18 Q4 through 19Q3 to adjust for what we believe to be an anomalous property included in the NCREIF database during those quarters. This re-calculation in the results in a re-calculated All-Region NCREIF return series during the same period. Ibbotson Assoc. database was used for S&P 5, U.S. T-Bill and S&P Forest Products quarter-end returns (dividends reinvested). Figure 7. Total quarter-end returns to securitized timberland based on internal analysis. The Total Securitized Timberland Index includes Plum Creek (PCL), Crown Pacific (CRO), U.S. Timberlands (TIMBZ), Deltic (DEL) and The Timber Company (TGP). The MLP/REIT Securitized Index includes PCL, CRO and TIMBZ (dividends reinvested). Figure 8. The HSTI uses a base-weighted aggregate methodology (similar to that used to construct the S&P 5) to calculate a market capitalization-weighted value for five publicly traded timber-intensive forest products companies. Base weights were readjusted for the emergence of new companies or at the beginning of each year. Dividends are not reinvested. References to expected investment performance in this newsletter are based on historical information and are not to be interpreted as guarantees of future results. 6 Hancock Timber Resource Group High Street, Boston, MA