Q23: Why now?
It is now possible to create new forests in the United States for profit.
The traditional forestry business model is:
- Buy an existing forest.
- Cut down ~5-10% of the trees each year and sell the wood to generate cash.
- Use some of that cash to replant the trees we just cut down and dividend out the rest.
- Repeat 2-3. As we cut down old trees, new ones take their place, so the forest can be rotationally harvested forever.
This is a great business model. Globally, over $470B is invested in timberland, with $165B of that in the United States. Weyerhaeuser, the largest timber REIT, is worth $14B at the time of writing and pays out a $1B annual dividend. But to fight climate change, the world needs new forests, not just the sustainable management of existing ones.
Historically, the only people planting new forests were (a) non-profits, or (b) small-scale ranchers and family farmers. This is because the cash flow profile for new forests involves a 20+ year J-curve followed by a perpetual but not-particularly-exceptional yield (e.g., WY’s yield has historically been 5-7%). As a result, it has previously not been possible to mobilize large sums of resources and capital for the creation of new forests.
I believe that as of 2020, things have changed, such that it is now possible to do for-profit, large-scale re- and afforestation in the United States. I have identified 5 major and recent changes that make this possible:
- The CA carbon offset market has matured and become reliable.
- CA’s cap-and-trade program was recently extended through 2030, and Governor Jerry Brown signed executive orders binding the state to carbon neutrality by 2050, providing regulatory stability.
- We have now completed several compliance periods in the CA cap-and-trade market, so we have multiple years of market and pricing data to work with.
- CCOs are now traded on a major exchange (ICE) as of mid-2019.
- CCO futures trading also started in 2019.
- Land and debt have become extremely cheap due to COVID-19.
- Rural land values are tanking due to COVID-19. Earlier this month, the Rural Mainstream Index dropped to its lowest level since January 2006 (!).
- In rural areas, approximately 94% of bankers expect COVID-19 to produce a recession.
- Farmland prices have moved sideways for 76 of the past 77 months.
- Debt is historically cheap. The fed funds rate has fallen to almost 0%.
- A global consensus has emerged around tree planting as a solution to climate change.
- Tree planting as a solution to climate change is probably the only thing that climate scientists, Marc Benioff, Greta Thunberg, and Donald Trump have all endorsed.
- Forest fires in California and Australia have alerted the public to the need to conserve existing forests and plant new ones.
- Large corporations like Delta, Microsoft, Google, and more have all pledged to become carbon neutral in the near future, and plan to do this in part through the purchase of offsets, most of which come from forestry.
- Global climate survival protests have hit major cities all around the world; climate change is in the zeitgeist.
- Institutional investors are now seeking climate-positive investments.
- Larry Fink, the CEO of Blackrock, the largest asset manager in the world, highlighted climate change as the major theme of his 2019 annual letter to CEOs.
- In December 2019, investors from 631 firms representing over $30 trillion in capital wrote an open letter urging world leaders and institutional investors to work together to accelerate solutions to climate change.
- The projected yield from Evergrow now looks great, thanks to the impact of COVID-19 on interest rates and commercial real estate, and recent changes to the US tax code.
- Traditionally, commercial real estate and bonds (corporate and sovereign) have been where institutional investors get yield. Both of these have been severely impacted by COVID-19. In the case of CRE, the impacts may be long or even permanent given the implications of COVID-19 on the future of work and offices.
- Forestry assets provide yield and are not correlated to interest rates or commercial real estate, making them highly attractive sources of yield at the moment.
- The 2018 Tax Cuts & Jobs Act gives a 20% deduction on dividends from pass-through entities, lowering the effective tax rate on Evergrow’s dividends, making it even more compelling for institutional investors seeking yield.
- The benefits of the 20% deduction on dividends can be stacked with the opportunity zone regulations, which provide for capital gains deferral and elimination if our forests are located in opportunity zones.
Most of the changes listed above happened in the last 6-12 months. The oldest dates from 2017. Taken together, I believe they make it possible to do large-scale, for-profit reforestation in the United States. For Evergrow, the time is now.