Forestry

The main driver of returns on forestry investments is the biological growth of trees, which is completely independent of economic developments and financial markets. On the one hand, this results in ongoing asset growth, while on the other hand, harvesting measures dependent on the age of the trees (i.e., the age classes of the forest) ensure ongoing cash flow.

_{Source: Caulfield, J. P. 1998. Timberland return drivers and investing styles for an asset that has come of age. Real Estate Finance 14(4):65-78.}

Certification in forestry is a voluntary, global process for labeling forest products that have been produced in an economically, socially, and ecologically sustainable manner with a seal of approval:

• PEFC = Program for the Endorsement of Forest Certification Schemes, founded in 1999, >300 million hectares certified, pefc.de
• FSC = Forest Stewardship Council, founded in 1993, >165 million hectares certified, fsc-deutschland.de

Assessing risks related to natural disasters and climate change is essential during the purchase and ongoing management of assets:

• Climate change has an impact on long-term weather patterns
• Natural disaster risks are particularly relevant for forestry investments
• Diversification reduces these risks
• Insurance coverage is available for most assets
• Active risk management is essential. Munich Re has outstanding expertise in this area

Forest investments have an attractive risk-return profile and offer institutional investors the opportunity to further diversify their capital investments. This allows investment risks to be spread more widely. The correlation with other investments traditionally made by institutional investors, especially in times of crisis, is low, as forests grow completely independently of economic developments and the financial markets. In addition, fluctuations in timber prices can be offset through active management → in times of low timber prices, the trees are simply left standing and, depending on the region, can grow by up to 10% in volume and thus also in value ("store on the stump").

Ideal for professional investors:

• With a long-term investment horizon
• With the aim of additional portfolio diversification
• Looking for an opportunity for attractive cash flows
• With a strong focus on land as a valuable asset
• With an interest in sustainable investments

A key reason for MEAG to invest in forestry is to generate stable long-term returns while providing the highest possible protection against downside risks. Sustainable management that takes ESG aspects1 into account and the assessment of natural risks in times of climate change play a central role for MEAG in this context. Against this backdrop, the current investment focus is primarily on the established forest investment regions of North America and Oceania, with opportunistic investments in selected European countries. MEAG has also gained significant experience in South America, Africa, and Asia.

MEAG takes natural hazards and climate change very seriously, and these issues are deeply rooted in the DNA of the MEAG/Munich Re Group. MEAG makes extensive use of Munich Re's expertise when selecting target regions for investment. This cooperation is intensified during the review process for individual transactions. For example, MEAG uses the risk models developed by Munich Re and engages in intensive dialogue with Munich Re experts. From MEAG's perspective, the main natural hazards are storms (e.g., hurricanes in the southern United States) and fires (e.g., in eastern Australia). Active management and tailor-made insurance solutions contribute significantly to reducing natural hazards. Overall, the average annual losses across Munich Re's entire portfolio since 2009 have been less than 0.2% of market values.

The return on forestry investments basically consists of two elements:

• The annual cash flow generated by harvesting activities and the sale of timber, and
• A return on value change driven by growth (increased volume)
• and the price of timber per assortment (e.g., saw timber, paper timber).

Returns depend on the respective investment regions, as local specifics such as the dominant tree species and their growth behavior, supply and demand on local timber markets and thus the level of timber prices, or cost structures also influence returns. The only available index for forest investments is the National Council of Real Estate Investment Fiduciaries (NCREIF) Timberland Property Index, which tracks the returns of professionally managed forest areas in the US. Since 2001, this index has shown an average annual return (IRR) of 6.5% at the forest area level (i.e., before any asset management fees). Based on our experience, IRR returns for new investments in the US (after local costs and taxes and before fees) are around 6.5%, while in Oceania, returns can be up to 1% higher.

The differences between forests in individual investment regions (e.g., the southern United States and New Zealand) can be immense. Significant differences include, for example, tree species (deciduous or coniferous), which have individual growth characteristics due to different climatic conditions, or demand from the forestry industry. In an investment region, for example, the age of the forest may vary (age class structure), which in turn can have a strong influence on the cash flow profile of the investment. Another important aspect is the quality of the soil, which in turn has a significant impact on the forest's profitability (growth). All these factors and a multitude of other parameters should be carefully examined as part of the due diligence process for a forest and require considerable expertise. MEAG has many years of experience in this area.