The boom of natural real estate investments

Driven by climate change and relentless population growth, arable land is not an abundant resource anymore. And because anything scarce becomes expensive, it comes as no surprise that asset managers are increasingly exploring natural real estate investments. Let us understand the rationale behind this trend and figure out whether buying lands is a wise climate investment strategy.

Ecosystem services and climate change mitigation

Nature-based solutions are considered a key element in the fight against climate change. Through conservation or sustainable management of lands such as forests, pastures or croplands, landowners and project developers can generate monetisable outputs such as carbon credits and other result-based payments, not to mention all the commodities humanity has been extracting from any given piece of land for centuries: food, fuel and materials.

Climate change impacts natural ecosystems functioning and ecosystems in turn have an impact on the climate, notably by releasing or sequestering carbon from and in various carbon pools (biomass, soil, oceans). Human activities have deeply disturbed this natural balance. The good or bad state of land conservation greatly influences global changes.

As 70% of the global ice-free land surface is affected by human activity, the recent IPCC report clearly states that “land degradation because of human activities is a significant contributor to global warming” and that unsustainable land management is responsible for “about 23% of anthropogenic emissions.” Afforestation, reforestation and bioenergy crops large-scale projects are vital elements of most scenarios that limit warming to 1.5°C or 2°C.

Arable lands, a scarce asset

Climate Foresight is all about climate trends. Have you heard of the concept of the browning trend? It describes the trends of decreasing photosynthetic activity due to global warming. In some areas, forests and grasslands are literally browning as a result of unusually high temperatures. This phenomenon will soon be commonplace in many regions where a warmer climate is projected.

Climate change dramatically increases the frequency of wildfires, extreme temperatures, heatwaves and changes in precipitations patterns. This will lead to irreversible desertification in large areas of the globe. Between 1982 and 2015, 6% of the world's drylands underwent desertification driven by unsustainable land use practices compounded by climate change.

On top of that, sea level rise and extreme weather events are responsible for arable land erosion. Shoreline recession is a visible change that directly reduces the surface of cultivable land, which is demonstrably aggravated by sea level rise. But soil erosion, though less tangible, is an even more impactful phenomenon as it has devastating and almost irreversible consequences on soil fertility over time.

Overall, the various ecosystem services provided by arable lands around the world are going to decline: agricultural production, timber and fuelwood production, air and water filtration, etc. In particular, most tropical and temperate geographies will observe a reduction in crop yields which therefore constitutes, among other perils, a major threat to food security.

Concomitantly, the global population will increase from nearly 8 billion in 2022 to well over 11 billion by 2100. In 2050, there will be almost 10 billion people to feed on Earth, a growth that would require an increase in food production by 50 %, from nearly 6 billion tons to 9 billion tons. What's more, we are all living on the same finite planet and what is predicted for food is also true for water and energy. Competition for land will only intensify, along with the need to reduce the many negative impacts of agriculture on the environment.

Humanity faces a risk of a scissor effect between the reduction of available arable land and world population growth. The surface of agricultural land per capita was divided by 2.3 in the last 60 years, from 1.45 hectares per capita in 1961 to 0.63 in 2018.

Given the current rate of desertification and the global population dynamic, this figure is very likely to be halved again by 2050, to reach 1,000 square meters per capita. In other words, each of us will roughly have two tennis courts worth of arable land in 2050 to grow crops and vegetables, keep a cow and a couple of chickens, harvest wood, and enjoy outdoor activities while preserving air and water quality and hosting biodiversity.

The 21st century Land Rush

China represents approximately 20% of the world’s population but possesses no more than 7% of the world’s arable land within its borders. To address the obvious underlying food security risk and build climate resilience, the Chinese authorities have been strategically buying lands abroad for 30 years. Similarly, arid but oil-rich Gulf States such as Saudi Arabia have been acquiring lands in more fertile countries in an attempt to secure their food supply while reducing their domestic water use. In recent years, the scale of this type of climate investments has increased dramatically in the Global South, with millions of hectares of public land being sold or leased to foreign companies and governments. Moreover, the growing demand for biofuels now conflicts with food production as land is diverted for producing non-food monocultures such as sugarcane, rapeseed, palm oil and corn.

The southern hemisphere is no longer the long-portrayed infinite reservoir of arable land capable of satisfying the voracious needs of the North. Furthermore, high timber prices, forestry values and emerging carbon and natural capital value have an increasing influence. Demand from different types of buyers has increased significantly, raising prices. Arable land value is understandably skyrocketing around the world, and double-digit increases in annual rate were not uncommon during the past ten years.

A Scottish case study

Well aware of this trend, asset managers and climate investment funds are unsurprisingly exploring the natural real estate space.

Investment fund managers Par Equity and Aviva Investors have recently acquired more than 6,000 hectares of moorland in Aberdeenshire in Scotland, and plan to undertake extensive peatland restoration work across around 1,800 hectares of land, and new planting of trees over around 3,000 hectares. The initiative is intended to sequester around 1.4 million tonnes of carbon.

The Scottish Land Commission just published a report (April 2022) describing the trends in the rural land market. The authors notably found that farmland values in Scotland rose by 31.2% in 2021. In particular, “poor grazing and grassland values increased by 60% in 2021, largely driven by forestry buyers, and 40% of all farms purchased in the UK in the past five years were bought by non-farming investors.” The carbon markets' dynamics and the appetite for natural assets are especially responsible for this evolution as “almost half of all estates purchased in Scotland in 2021 were sold to corporate bodies, investment funds or charitable trusts” interested in generating carbon offsets or other nature-based incomes.

As arable lands are expected to become a scarce resource in the coming decades, natural capital investments will certainly increase and the Scottish land market is likely to continue to experience strong growth.

How to invest in natural real estate

Natural capital is critical in the journey to net-zero and a healthier planet. Several initiatives currently intend to define principles to assess the value of nature, socially and economically, in the same way as man-made assets, so as to unlock private investments, increase arable land conservation and eventually tackle global environmental challenges.

Here is guidance for investing in natural real estate.

1. Understand climate change effects

Arable lands’ ability to produce ecosystem services will be strongly altered by global warming. It is therefore critical to understand how climate change will affect the region considered.

• Increased frequency and intensity of weather patterns, such as heatwaves and droughts
• Increased risk of coastal flooding and watershed flooding in rivers, streams, and other waterways
• Increased frequency and intensity of severe weather events like hurricanes, typhoons, and tornados
• Impact on crops and trees growing seasons and growing capacity due to droughts or extreme precipitation.

2. Consider various streams of revenues

Albeit controversial, generating returns on investment is key in channelling private funds to natural capital. Asset managers may consider various streams of revenues from nature-based solutions, each of these opening a door to an entire world of possibilities.

• Food production
• Timber production
• Carbon credits
• Biodiversity credits
• Other result-based payments
• Green tourism
• Land revaluation

3. Evaluate the local legal and political framework

Buying a piece of land is not as straightforward as investing in more commonplace classes of assets, especially in emerging countries. Plus, one must consider the local farmland market before making any investment and avoid any undesired competition that would compromise local subsistence agriculture.

• In numerous countries, the land is an inalienable good and only belongs to the state. Leasing becomes the only option available option for domestic and foreign investors.
• Public policies in place are likely to have a great influence on the potential for generating revenues (food export and timber production regulations, carbon accounting rules, etc.).
• Natural real estate investors face reputational risks and are often accused of neo-colonialism when their practices get close to land grabbing.
• The liquidity of the market is tricky to assess and defining a clear existing strategy might be complicated.

In conclusion, given the substantial need for channelling private capital into nature-based solutions, and bearing in mind the risk of land grabbing and cynic speculation, a fair and efficient way to scale up investments in natural real estate must be found so that arable lands can play their role in mitigating climate change before it is too late.