Timberland outlook: Demand remains strong
Timber demand remains strong as carbon interest accelerates
We anticipate strong cash yields for timberland assets in 2023 as well as rising prices and yields in 2024 and beyond.
Global demand for sawtimber and solid wood product remains strong compared with the pre-COVID-19 decade. Solid wood product demand is strong as it is a more sustainable and carbon-negative building material than cement and steel. In addition, underbuilt supply of homes in the United States and other areas of the developed world, the movement to a higher percentage of wood-based homes in various countries and an expanding manufacturing base have contributed to this demand.
While carbon markets are not new, the interest and investment in carbon offsets and projects – by both investors and users of offsets – has accelerated. We believe demand for carbon offsets is likely to exceed supply in the near and longer term. Forests provide the 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 Working forests also provide investors with other tangible ESG-related opportunities, from biodiversity to rural jobs, enhanced through sustainability-focused management, and verified by meeting third-party forest certification standards.
These highlights underpin our expectation of reliable income returns and capital appreciation in an asset class with inflation-hedging attributes. We anticipate strong cash yields for timberland assets in 2023, and rising prices and yields in 2024 and beyond.
Key themes: Tight supply, strong prices tempered by higher rates and an early-stage carbon opportunity
Pent-up U.S. housing and timber demand: New home construction, as well as repair and remodeling – together comprising about 70% of lumber demand – have softened in the second half of 2022, tempering increased log demand, which remained elevated, across the United States and Canada. Pent-up U.S. housing demand among younger homebuyers will continue to spur steady demand through 2023, with increased demand in the following three to five years (or more)2 as home prices and mortgage rates continue to moderate, improving affordability.
Longer term, a rising proportion of single-family homes (rather than multi-family units) being built will further boost lumber demand per unit,3 as COVID-19 has stimulated movement to lower density suburban and rural housing. Acceptance of engineered wood products, such as cross-laminated timber (CLT), in medium-rise construction globally has also increased lumber demand, with projections continuing to increase significantly, as illustrated in the chart below.
Global CLT consumption (construction only)
Supply chain disruptions diminished in 2022 and lumber prices have begun to normalize while production capacity has increased and reduced demand, bringing supply and demand back into balance. Lumber prices are expected to remain elevated as U.S. lumber companies build production capacity by modernizing, expanding and constructing new mills, tightening log supply.
Increasing global recognition that sustainably managed timberlands are a climate solution imperative: Forestland is a natural carbon-capture solution. The carbon sequestered by trees is being quantified, verified and used to offset greenhouse gas emissions (GGEs) by companies paying asset owners for carbon units or by asset owners offsetting their own emissions.
Carbon markets, especially the voluntary markets, remain small in comparison to total annual global emissions. The net-zero commitments by a wide range of organizations across the globe are significant and interest in carbon offsets is accelerating. The focus on proven projects and the use of forests makes a significant contribution toward net-zero commitments and creates a meaningful entry point for investors.
Scarcity of timberland: Global sawtimber supply is increasingly constrained relative to traditional demand drivers. Thus, investment opportunities will become increasingly limited as timberlands are sought for carbon sequestration, likely leading to capital appreciation in many regions of the world.
Timberland’s inflation hedge characteristics, particularly longer term: A forest’s value is not very volatile because biological growth continues during periods of weak pricing. Harvest can be delayed while trees continue to grow in size, and value is stored on the stump. 2022 effectively demonstrated the inflation hedging characteristics of this asset class as log prices increased, further supporting timberland values, particularly where log supply and demand are in balance.
Timber’s alignment with global and corporate ESG policy: Working forests offer an increasingly recognized array of ecosystem co-benefits, such as habitat for endangered species and shelter for much of the world’s biodiversity. Forests provide sources of clean water. And, importantly, wood-based construction is superior to steel or concrete from a GGE perspective.
Working forests also align with social goals, such as opportunities for public recreation. Forests can also provide living wage jobs, reduce urban migration and improve the quality of life in rural communities.
Technological advancements: Remotely sensed imagery and geographic information system innovations are making forest carbon and inventory measurement more cost effective, efficient and scalable, and are making carbon markets more widely accessible to large and smaller landowners. Drones are lowering costs and improving the safety of forest activities as well as fire detection. Other innovations are improving the costs and quality of surveying, reforestation, harvesting and wood products.
Timberland investing: Opportunities for diversification, climate, inflation hedging and ESG
A well-diversified 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, strong demand and improved prices lifted income. Returns could benefit further from tight log supply in the U.S. Pacific Northwest, Australia and Chile. Higher log values should help accelerate capital appreciation and compress discount rates, particularly in tight log market areas. And, carbon monetization could provide an additional overlay of revenue potential.
Looking forward, potential risks include an anticipated economic slowdown in 2023 that dampens housing demand in response to government policy measures that slow economic growth. Housing affordability is currently a risk, although mortgage rates and home prices have already begun to recede. Further declines are likely, improving affordability as government policies to control inflation are no longer needed.
Continued expansion of new home construction depends on construction labor availability at costs that do not hurt affordability. (Labor availability constraints are more likely to defer new home construction than reduce new home demand.) Remaining supply chain disruptions should lead to greater reliance on local or regional log and lumber sources, benefiting some log markets but not others.
Based on the FEA’s projections illustrated in the chart below, U.S. lumber consumption and log demand will expand once again in the next 12-18 months, driven by pent-up housing demand for new home construction as well as repair and remodeling demand, while existing homes available for sale will be constrained. Existing homeowners may be reluctant to sell because they cannot replace their existing very low-rate mortgages with something similar, putting more pressure on new home construction. Australian lumber consumption will remain elevated, compared to prior decades following some near-term softening in new home construction due to higher interest rates.
Softwood lumber consumption by major end-use