Investing in Nature

Case Studies of Land Conservation in Collaboration with Business

By William J. Ginn

ISLAND PRESS

Copyright © 2005 William J. Ginn
All rights reserved.
ISBN: 978-1-59726-013-8

Contents

About Island Press,
Title Page,
Copyright Page,
Table of Figures,
List of Tables,
Acknowledgments,
Introduction – The Scale of Nature,
Part I – Conservation Investment Banking,
1 – Partnering with Big Timber,
2 – Debt for Nature: The Story of the Katahdin Forest,
3 – Bankruptcy and Biodiversity,
4 – Investing with an Attitude,
Part II – Creating New Environmental Markets,
5 – Carbon and Forests,
6 – The Bank of Nature,
Part III – Incentives,
7 – Greening Business,
8 – Tax Credits for Conservation,
9 – Incentives for Working Landscapes,
Part IV – The Path Forward,
10 – If You Build It, Will They Come?,
11 – Conservation at the Scale of Nature,
12 – Crossing the Divide,
Notes,
Bibliography,
Index,
Island Press Board of Directors,

CHAPTER 1

Partnering with Big Timber

The record clearly shows that conservation can’t succeed by charity alone. It has a fighting chance, however, with well designed appeals to self interest. The challenge now is to change the rules of the game so as to produce new incentives for environmental protection, geared to both society’s long-term wellbeing and individual’s self-interest.

—Gretchen Daily and Katherine Ellison, The New Economy of Nature

When rumors of a gigantic sell-off of forestlands by International Paper (IP) reached the state capital in Concord, New Hampshire, it set off alarm bells in Governor Jean Shaheen’s office. At nearly 4 percent of the entire state, such a land sale was bound to get attention, and New Hampshire’s fragile North Country economy was already suffering. Months before, the paper mill complex in Berlin and Gorham had filed for bankruptcy and was shuttered. For the first time in a hundred years paper machines stood idle, putting one thousand mill and forest workers out of jobs and undermining the local economy. The timing of a sell-off could not have been worse.

Working quickly, the governor and the state’s powerful senior U.S. senator, Judd Gregg, arranged for high-level meetings at IP’s Stanford, Connecticut, offices. Still a major land and mill owner in the Northeast, IP recognized that the political fallout of not working with the state would be significant so they gave their grudging agreement to a few months’ stay. A consortium of conservation groups, led by the Trust for Public Land (TPL), was designated by the state to lead the negotiations.

At a property valuation of over $30 million, no conservation group had nearly enough money to buy the land alone, and certainly the state, embroiled in an intense debate over education funding, was in no position to front the money. What’s more, the communities in the region were wary of conservation groups that might undermine the already suffering forest economy by reducing forest productivity or reversing the long history of public use for snowmobiling and hunting.

What could have been a protracted conflict over the future of the property, however, evolved into a remarkable partnership that met both the needs of the local community for a solution honoring the long tradition of a forest-based economy, and the interests of the conservationists in protecting the property’s biodiversity values. The key partners in this effort were a private investment group managed by Lyme Timber Company; the Society for the Protection of New Hampshire Forests, a savvy and capable statewide conservation group; The Nature Conservancy (TNC) with its focus on reserves and biodiversity; and the TPL, with its long experience in developing recreation access and insuring sustainable management of working landscapes.

TPL proved a good choice for managing the exhausting negotiations. Working with the community was at the heart of the challenge in northern New Hampshire. For the past decade the TPL under the leadership of Will Rogers has been shifting its focus from “doing deals” to embracing land conservation as a way to strengthen and heal divided communities. As Rogers observed, “We need to realize that the work is not about conserving places. It is about conserving people and our fellow species in the web of life. It is about helping people find a different way to live.”

Community members were conflicted. On one hand, they desperately wished the whole thing would go away—they had become comfortable with the status quo and feared that all of this outside interest would cause them to lose control over their livelihoods. On the other hand, they recognized that change was inevitable and the communities had a golden opportunity to shape their future. TPL’s capable north country manager David Houghton and a bright, articulate forester, Charlie Levesque, hired on as the local project manager, lived and breathed this project for nearly a year, developing a relationship of trust with all of the parties. This investment in understanding the community went a long way in keeping the political coalition together that ultimately resulted in a multimillion dollar legislative appropriation and $12 million in forest legacy funding.

When the deal closed in March 2003, Lyme had put up $12 million in private capital to purchase one hundred and forty-two thousand acres of working forest; TPL had secured a working forest easement over the property, at a cost of about $15 million; and TNC had purchased twenty-five thousand acres as a wildlife management area for over $5 million for later transfer to the State with TNC retaining a conservation easement. The needs of the stakeholders for a sustainable solution that incorporated conservation shaped the transaction, and each of the partners benefited from the wholesale price negotiated with IP. But above all, the private capital investment by Lyme made the economics of the deal work.

Engineering the financial components of the deal proved challenging for TPL, the partnership’s leader. Because of IP’s timeline, the forest easement could not be negotiated before the deal needed to close. At that point Houghton convinced Lyme to provide its money upfront as a loan, with an agreement that the fee purchase price would be adjusted up or down once the final easement was appraised. This proved beneficial because it took nearly two full years for the details of the easement to be negotiated and for a final transfer of the easement-encumbered land to Lyme. This saved TPL the cost of commercial borrowing, and bought time in what otherwise would have been a nearly impossible schedule to meet. For its part, Lyme had the comfort of knowing its inventory of trees was growing and that it would receive forest harvest revenues during the loan period.

The Connecticut headwaters transaction is not an isolated example of working with private capital. Opportunities for conservationists to create these partnerships are significant and growing. An unprecedented sea change in corporate ownership of working forests has resulted in millions of acres of land that have suddenly become available for purchase. In some states, the challenge has been extreme. In dozens of huge transactions in Maine, over 35 percent of the entire state has changed hands in the last five years. This crisis of opportunity has been the crucible in which many interesting new conservation agreements with private capital have been forged. The strain on the resources of conservation groups and government has made working with private capital an imperative, not an option.

Since the early 1990s another reality has emerged. Over $20 billion has been invested in timber investment and management organizations (TIMOs) and real estate investment trusts (REITs). In 2003 alone, these new alliances invested $4 billion, largely from pension funds and endowments, to purchase 5.2 million acres of timberland in the United States. The creation of these investment vehicles is a fascinating bit of financial history. Until the 1980s integrated paper and pulp companies owned most of the large commercial forest estates in this country. The land was viewed as essential to the supply of fiber to their nearby mills. A few major companies began to realize that they had a huge asset in their timberlands, yet they were being managed by mills interested only in reducing the costs of operating the forest holdings, not in increasing their profitability. IP and Georgia Pacific were among the first to set up their forestland holdings as separate business ventures and to expect both the mills and the forests to make a profit.

Two significant trends emerged with this seemingly subtle change in management strategy. First, forest managers could no longer look to the mills for investment cash—they had to manage the forests to make money. Quietly, some began to sell off nonstrategic assets that were too far from markets or unproductive as tree-growing land. And, of course, selling land, especially lakeside property, to developers also generated profits without cutting significantly into the harvestable wood supply.

Secondly, mill managers, freed of buying fiber from themselves, began to find that in a global marketplace, pulp from overseas and fiber from other landowners were often cheaper. Senior managers at the major forest products companies began to question openly whether maintaining their own fiber supply made any sense. Why not buy fiber or pulp from the cheapest source and thereby increase company profitability and shareholder value?

When Hancock Life Insurance Company put together the last piece of the puzzle, the ownership transition began in earnest. The insurance company formed Hancock Timber Resources, thus putting its financial stamp of approval on a new way of owning timberlands—limited partnerships. The genius behind this idea was the recognition that the traditional paper companies pay high taxes at the corporate level and shareholders paid taxes again when they received dividends, resulting in tax inefficiencies for corporate landowners. By forming limited partnerships, “passive” tax-exempt investors such as pension funds, university endowments, and foundations could own interests in forestland directly. The profit for businesses owning forestland jumped by the amount of the tax savings—as much as 20 to 35 percent. And no more trees need be cut. Almost overnight these huge sources of capital began to look for limited partnership investments in timber.

Tax-saving benefits began to play a big part in the creation of REITs. REITs were originally set up to allow real-estate owning companies to sell shares on stock exchanges. Like limited partnerships, the ultimate recipient of the income, not the REIT, pays the tax. The objective of early REITs was to attract investment capital for commercial real estate—shopping centers and office buildings—but a group of astute businesspeople at Burlington Northern Company, a land rich railroad company, realized the REIT approach was equally applicable to owning forestland. Shareholders would have tax advantages such as limited partnerships, but also be able to simply sell or buy stock on the market without selling the forestland to get their return. Today, the successor corporation to Burlington Northern, Plum Creek, organized as a REIT, is the largest private timberland landowner in the United States, owning over 8 million acres. Thus, with powerful new tax structures and increasing recognition in the traditional paper industry that fiber supply and land ownership were separable, the race for America’s timberlands is on.

Five years ago none of the TIMOs or REITs would have appeared in a list of the fifteen largest forestland ownerships, and today the major sellers to investors continue to be traditional industrial landowners. IP owned 11 million acres in the year 2000. Now it has been eclipsed by Plum Creek as the largest forest owner.

One major difference between traditional owners and the new investors is the relatively short time the investors intended to hold their land. In 2003 new investors Plum Creek, Campbell and Hancock were the biggest buyers and the biggest sellers. With TIMO partnerships typically having a limited life of eight to twelve years, the exit strategy is the sale of the land. Pension funds, the largest source of capital for TIMOs, are required by law to return the highest profit to their pensioners, and that value is often achieved by splitting up the land or developing high-value shore frontage.

The industry is so new that the conservation impacts of these secondary sales have yet to be fully realized, but we have two good examples that suggest cause for alarm. In late 2002, Hancock Timber began selling off five hundred thousand acres acquired for the California pension giant CALPER. This land was bought in a handful of units over the years for CALPERs and was resold in dozens of blocks. Similarly, IP has begun to act more like a TIMO in its sales of land. In 2003, IP created a new company called Blue Sky that sold about 885,000 acres last year in an astonishing 548 separate transactions. For conservationists these trends are troubling. As holdings become fragmented into smaller and smaller blocks, development, liquidation harvesting, and conversion begin to rise dramatically.

Yet this very trend makes for extraordinary conservation opportunities. Unlike the past when industrial owners spurned conservation organizations, the new owners look to conservationists as major buyers of their lands. In fact conservation interests were the fourth largest buyer of forestlands in the United States in 2003.

The central problem for conservationists is to avoid being a retail buyer of small parcels at a premium price while adroit TIMOs, with access to far greater capital, pick up all of the large properties on the market, giving them control of the properties’ future. The solution is simple but not easy to implement. Conservationists and their allies need to be prepared to purchase the large parcels that contain properties of high conservation value within them. This allows conservation to control the deal and to set priorities for the ultimate use of the property. But purchasing large properties can be a daunting proposition. In 2003, the most expensive purchase of forestland was Campbell Group’s $401 million acquisition for Mass PRIM, a pension fund, and in that year there were ten other transactions in excess of $100 million.

Assembling the conservation capital to bid on these huge projects is possible, as demonstrated by TNC’s $35 million St. John purchase and the Conservation Fund’s $72 million/three-hundred-thousand-acre Champion International project in New York, Vermont, and New Hampshire. Still, this is a daunting prospect for most land trusts and has not been often repeated, partly because of the new model forged in the IP Connecticut Headwaters transaction and dozens of similar deals. In these new joint ventures conservation groups and private investors have purchased properties together, sharing the risks and benefits. As in the Connecticut deal, working-forest portions of the properties, usually encumbered with easements, are transferred to the investors while key conservation assets are retained. Both parties get the benefit of wholesale transaction prices.

In TNC’s purchase of the St. John’s 185,000 acres in Maine, private donors contributed the entire $35 million dollars. Today TNC owns the full property and has a model demonstration forest project on ninety-five thousand acres, with the rest in reserves, where biodiversity is the main management focus. The almost identical scale purchase of the Connecticut Headwaters from IP cost $32.8 million dollars, but instead of conservation footing the entire bill, private investors provided $12 million to purchase timber rights, reducing by more than a third the conservation capital required. Here is a comparison on the two transactions.

In many cases the question of whether to buy it all or to split the cost with private capital is academic. Without private capital, most land trusts will not be able to take the financial risks in these huge projects. How these costs are shared is highly specific. In the IP Connecticut Headwaters project, TNC wanted at least twenty-five thousand acres of reserves—and was willing to raise the money. Thus the costs were more heavily weighted toward conservation than a pure easement deal. The capital from private investors will be determined by the income from forest harvesting, the timber inventory on the property, the local markets for wood products, and the conservation restrictions on harvesting and development.

The IP headwaters transaction was preceded by a number of smaller but equally interesting transactions such as TNC’s Tug Hill project, sandwiched between New York’s Adirondacks and the eastern end of Lake Ontario. Tug Hill is well known for its heavy snows, averaging three hundred inches of snowfall and fifty-five inches of precipitation annually. TNC had long been eyeing a forty-five-thousand-acre parcel owned by Hancock Timber right in the geographic bull’s eye of this northern hardwood landscape. Tug Hill is also one of the poorest regions in all of New York. While the Carnegies and Rockefellers lounge just over the Adirondack border, Tug Hill has attracted few tourists and even fewer philanthropic dollars over the years. To make this purchase work, it was critical to use conservation dollars efficiently and to attract public funds.

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