Timberland REITs own more than 15 million acres of land in the United States, and the stability of their underlying assets, alongside a capacity to generate additional income from areas beyond their traditional focus on timber and wood products, puts the sector in a favorable spot for 2024, analysts say.
REIT.com spoke with Michael Roxland, director of equity research at Truist Securities, and Kurt Yinger, analyst at D.A. Davidson, for their thoughts on sector performance, the importance of scale, the benefits of mass timber, the voluntary carbon market as a potential revenue generator, and more.
Q: What are some of the unique investment aspects of timberland REITs that set them apart from other property sectors?
Michael Roxland: One of the unique features regarding timberland is that it will continue to grow in value when left on the stump. Based on our estimates, trees grow approximately 3%-5% per year. Over time, this has helped maintain timber price stability as owners can reduce harvest volumes during periods of excess.
Moreover, there are several ways timber REITs can generate value: selling standing timber; selling timberland (in some cases for its higher-and-better use potential such as development if close to urban centers, etc.); leasing/permitting of land for recreational purposes; ground leases and easements granted to wind and solar developers to generate renewable electricity; rights granted to explore, extract, and sell construction aggregates such as rock, sand, and gravel, industrial materials, and oil and natural gas; and, rights granted to access and utilize timberland acreage for communications, pipeline, powerline, and transportation rights of way.
More recently, timberland owners have been engaging with corporations to sell them carbon offset credits instead of harvesting logs.
Kurt Yinger: In our view, the stability of the underlying asset values is one of the more unique and appealing aspects of timber REITs. The growing role of the forest in advancing sustainability and climate objectives, and the natural biological growth of the assets, we believe also differentiates the sector.
Q: As you look out across 2024, what are you anticipating in terms of timberland REIT performance and what are the main factors driving your forecast?
Yinger: We expect 2024 to be a year of more normalized performance, which follows a 2023 marked by moderation on several fronts. Log prices in the Pacific Northwest and U.S. South seem to be stabilizing, and lumber prices enter the year at levels where we believe it’s far more likely we see upside as opposed to further deterioration.
Single-family new residential construction activity looks poised for a rebound in 2024, a positive for wood product consumption, and in turn log demand. Builders have been willing and able to provide attractive incentives to capture a greater share of would-be homebuyers, augmented by low levels of competing existing home inventory. While we have yet to see the same type of positive inflection in residential repair and remodel activity, the largest consuming segment of lumber, stable home prices are expected to keep home equity levels elevated, and the “lock-in” effect has the potential to spur additional activity.
Large scale U.S. South timberland transactions continue to be completed at healthy per acre values, and we believe an improving lumber market is the most likely catalyst for shares of the timber REITs to narrow the discounts at which they currently trade versus our NAV estimates.
Roxland: We expect overall EBITDA for the timber REITs to increase in 2024, primarily due to improvement in their wood products businesses from continued improvement in single-family residential construction. Changes in the yield curve should have a corresponding impact on interest rates. This in turn will impact housing demand, especially single-family home construction, and therefore wood products demand and ultimately timber demand. We expect more limited improvement in timber EBITDA due to modest increases in harvest volumes and prices.
Q: We’ve seen consolidation in the timberland REIT sector, most recently with Potlatch Deltic Corp. (Nasdaq: PCH) acquiring CatchMark Timber Trust. How important is scale?
Roxland: Scale is important because it affords species diversity, broadens customer relationships, increases efficiencies in forest management, transportation, logging, and infrastructure, and enhances highest and best use acreage and subsurface assets.
In the case of PotlatchDeltic’s acquisition of CatchMark, PotlatchDeltic was able to gain immediate scale in growing end-markets in Alabama, Georgia, and South Carolina, new markets for the company with attractive site indices (a metric used to determine the productivity of a stand of trees) and strong stocking levels. The acquisition also allowed PotlatchDeltic to further explore real estate sales and natural climate solutions projects.
Yinger: One of the biggest benefits to scale in the timber REIT space is the diversification of log markets. Being overly concentrated in a single market poses the risk that a mill shutdown or change in operating posture from a manufacturing customer can significantly impact the supply-demand balance of logs in a given area, and adversely impact pricing.
Looking at some of the larger public combinations in recent years, the most significant area of synergy capture is in selling, general, and administrative (SG&A) reductions, and eliminating duplicative overhead and public company costs. A well-capitalized peer can also provide the financial flexibility to make certain investments to capture more value from the existing asset base. Overall, while there are certainly benefits, we believe scale is less important for the timber REITs relative to other sectors.
Q: Do you see the use of mass timber becoming more mainstream, and what impact could that have on the timberland REIT sector?
Roxland: Mass timber could become more mainstream and ultimately benefit timber demand over time if it gains additional traction in construction applications. That said, at present, a majority of demand for cross-laminated timber (CLT), the prevalent mass timber panel, comes from industrial uses such as access mats in oil fields and temporary roadways for heavy machinery and oil drilling, while a minority comes from construction, mainly non-residential including industrial buildings, hotels, warehouses, and schools.
In recent years, CLT has gained some momentum in residential construction, primarily multifamily, that relies on modular construction. Increasing usage has been driven by efficient construction and the pace at which multifamily units can be constructed on the job site. It is important to note that CLT tends to work best and is more cost effective in buildings at least five stories tall and in locations where labor is tight.
Yinger: Mass timber is likely to become more mainstream, but we expect that will be a slow, drawn-out process. Changing the materials used and how structures are built is no small task. Driving increased awareness and familiarity among architects and contractors, in addition to finding a way to lower costs, will be important in expanding adoption.
We have seen estimates that suggest over the next decade mass timber could drive an incremental 1-2 billion board feet (bbf) of lumber consumption in the U.S., or roughly 2%-3% of North American industry production. This would certainly be an incremental positive for log demand, but relative to the impact of changes in residential construction activity, or even the shifting geographic skew of lumber production, the impact from growing usage of mass timber on log consumption we expect will be fairly modest.
Q: Do you anticipate the voluntary carbon credit market becoming an established source of revenue for the timberland REIT sector?
Roxland: I think the voluntary carbon market could become an established source of revenue for timber REITs over time. Unlike the U.S. compliance market, which is derived from government regulations to reduce greenhouse gas emissions, the voluntary market primarily serves buyers seeking ways to meet carbon reduction commitments, such as net zero targets, and is in the early stages of development.
Yinger: We believe that voluntary carbon credits will absolutely become an established source of revenue for the timber REITs. In our view, the better question is, how meaningful can the sale of carbon credits be relative to traditional harvest operations? Given where voluntary carbon credit pricing stands at the moment, the timber REITs have indicated that it largely only makes economic sense to develop projects on relatively unproductive acreage, whether that be due to the type of logs harvested, or the underlying pricing or demand characteristics in that region.
While forest carbon is perhaps the most widely discussed of the climate-related monetization opportunities for the timber REITs, ultimately, we believe it will be one element of a larger opportunity set that includes more traditional opportunities like mitigation and conservation, and leasing land for renewable energy providers. Carbon capture and storage (CCS) is another opportunity, though one that requires very specific subsurface geological properties and thus will be very location dependent.
Q: What else are you watching in the timberland REIT space for the year ahead?
Roxland: I am monitoring end-market demand for timber. Over the last 18 months, there have been several paper and pulp mill and line closures, which we believe could cause certain pulpwood baskets, mainly in the U.S. South, to become less tensioned and for pulpwood prices to decline.
Yinger: Growing institutional interest in the timber asset class, driven at least in part by forest carbon opportunities, is a trend worth monitoring. On the one hand, an expanding pool of buyers with different investment priorities could make it more difficult for the timber REITs to acquire timberland that meets their return criteria, though it would also presumably have some level of positive impact on the value of their existing ownership. How that is reflected, or not, in terms of the value of the timber REITs in the public equity markets is a dynamic that will be interesting to watch unfold.