investment fund structuring - duke...

1Proprietary and Confidential, Timberland Investment Resources, LLC

Tom JohnsonTimberland Investment Resources, LLC

Investment Fund Structuring

Investment Fund Structuring


Agenda

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Types of Timberland Investors

Investment Considerations

Typical Fee Structures

Types of Investment Structures

Structure Considerations

Key Contract Related Considerations

TIMO Case Study


TYPES OF TIMBERLAND INVESTORS


Vertically Integrated Manufacturers

Traditional model has been virtually abandoned in the U.S.

Still viable in non-U.S. markets (less market depth and concern about access to fiber resource)

Active Individual Investors

Non-Industrial private landowners

Passive Individual Investors

Timberland real estate investment trusts that are publicly traded (Timber REITs, e.g., Weyerhaeuser)

Other minor vehicles that have proven less popular

• Exchange Traded Fund (ETFs, e.g., Cambium and Phaunos)

• Non-traded publicly-registered REITs (e.g., the former Wells Timberland fund, which is now a publicly-traded Timber REIT called CatchMark)

Institutional Investors

Types of Timberland Investors


Direct Institutional Investors (Foreign and U.S.)

Public Pension Funds (e.g., CalPERS)

Private Pension Funds (e.g., General Motors)

Endowments (e.g., Harvard University Endowment)

Foundations (e.g., The Gates Foundation)

Taft -Hartley Plans (e.g., Sheet Metal Workers National Pension Fund)

Insurance Companies (e.g., general reserve account assets)

Indirect Institutional Investors

Fund-of-Funds

Types of Institutional Timberland Investors


INVESTMENT CONSIDERATIONS


Institutional Investor - Investment ConsiderationsInvestment Objectives

ReturnRiskDiversificationInflation ProtectionCash Flow

ApproachAllocation driven

• By region• By species• By specialty (e.g., conservation)

Deal driven• Availability of appropriate deal flow


Institutional Investor - Investment ConsiderationsConstraints and other Considerations

SizeFund

Typically a $2.5 million minimum investmentPotentially more diversification but less controlPossibly higher fees

Separate accountTypically a $50 million minimum investmentMore control, possibly lower fees, potentially less diversification

TaxesTaxable investors: Generally capital gains treatment for timberland and timber sales held more than 12 monthsU.S. tax-exempt investors: Not taxable, unless unrelated business taxable income (UBTI) is triggered (e.g., dealer sales of timberlands or debt financed income). “Super” tax exempt investors (e.g., public pension funds) generally claim an exemption to UBTI.Non-U.S. investors: Income from U.S business operations and, under the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”), gains from the sale of U.S. real property interests, including timberland, are treated as Effectively Connected Income (“ECI”) which non-U.S investors must report on U.S. tax returns and is taxable at regular U.S. tax rates.

Exceptions include the use of a Corporate Blocker, REIT investments by an investor that is considered a “Qualified Foreign Pension Fund,” and the sale of REIT interest in a “domestically controlled” REIT.


TYPICAL FEE STRUCTURES


Asset Management Fee

Ongoing fee calculated as a percentage of assets under management

• Committed or invested capital, market value, or some combination of these

Carried Interest

Based on a hurdle rate or preferred return (real or nominal)

Manager participates in returns over the hurdle

Incentive to perform and generate realized returns

Less Common Fees

Acquisition fees

Disposition fees

Other - Property Management Fees

Third-party or charged by a captive subsidiary

Other – Pass-through of specified costs and third-party fees

Professional (legal, accounting, etc.).

Institutional Timberland – Typical Fee Structure


TYPES OF INVESTMENT STRUCTURES


Limited Liability Company (LLC) or Limited Partnership (LP)

“Private Equity” Timberland - Structure Options

Generally classified as “partnerships” for U.S. income tax purposes

No entity-level U.S. income tax; instead, the partners are subject to tax on their share of the partnership’s income, whether or not distributed to investors (pass-through)

UBTI issues for tax-exempt investors and FIRPTA-ECI issues for non-US investors – the structure does not alleviate these issues

Appropriate for both separate accounts and commingled funds

Recommended for accounts or funds that involve a co-investment by manager


Private Real Estate Investment Trust (REIT)


Character-through for U.S. tax purposes, similar to an LLC or LP

• Dividends from the REIT are characterized and taxed to shareholders according to the underlying income generating the dividend (ordinary or capital)

Specific Advantages for U.S. Tax Exempt Investors

• For U.S. tax-exempt investors, a REIT blocks UBTI attributable to debt-financed income

Specific Advantages for Foreign Investors

• If U.S. shareholders hold more than 50% of the REIT (“domestically controlled”), foreign shareholders can sell interests and avoid FIRPTA on sale of shares, but capital gain dividends generally subject to FIRPTA withholding and tax

• Even if the REIT is not domestically controlled, a shareholder that is a “qualified foreign pension fund” would generally escape FIRPTA withholding and taxes

More complicated and expensive structure to maintain

Strict rules for REIT qualification and avoidance of penalty taxes (e.g., sales are limited, or TRS must be utilized)


Corporation (C-Corp or LLC taxed as a C-Corp)


C-Corp “blocker” – the investor invests in shares of the corporation which eliminates the need to file tax returns and pay taxes for non-U.S or tax-exempt investors

C-Corp blockers are subject to an U.S. federal entity level tax (corporate tax) at 21%

Debt is often used to lower the taxable income and effective tax rate (because of interest expense)

A TRS also utilizes a C-Corp blocker to generate non-REIT qualifying income (e.g., land sales in excess of the safe harbor)


STRUCTURE CONSIDERATIONS


Cost

Complexity

Tax efficiency

Co-investment• Partnership structure as a way for the manager to obtain

capital gains treatment for carried interest• Lurking political pressure to remove this benefit

U.S. vs. Non-U.S. investors• Frequently, U.S. and foreign investors have different

preferences for investment structure (for example, a foreign investor may prefer to utilize a blocker but a U.S. investor generally will prefer a pass-through)

Taxable vs. Tax-exempt investors• U.S. tax-exempt investors generally have to avoid UBTI

(e.g., dealer property sales), whereas taxable investors don’t have those restraints on income



Timberland Investment Holding Structures Simple to Complex Operations Based on Needs



KEY CONTRACT RELATED CONSIDERATIONS


Matching structure with investment goals and investor type

Fund vs. Separate Account• Investor size • Liquidity requirements• Term considerations (fixed vs. evergreen)• Tax considerations (one size fits all for a fund)• Up-front legal costs (fund versus separate account)• Fund has a limited “shelf life”

Investment Objective

Specificity versus flexibility/opportunistic

Return objective and benchmark(s)• Absolute benchmark• Relative benchmark

Diversification • Geographic• Species

Leverage (yes or no, any limitations and impact on fees)

Key Management Contract Considerations


Duties of the manager

Fiduciary obligations

Insourced vs. outsourced functions

Key person(s) provision

Fee

Asset management fees

Incentive fees• Hurdle• Carry

Other (e.g., disposition fee)

Alignment of interest

Agency risk - The risk that the management of a company will use its authority to benefit itself rather than the investor



Governance

Advisory board• Generally comprised of significant investors• Deals with conflicts and other duties

Control of major provisions• Term• Manager removal• Other

Term

Fund• Original term• Any extensions

Separate Account• Original term



TIMO CASE STUDY


Case Study

TIMO

Founded in 2004 by 6 principals

Headquartered in Atlanta, Georgia

Has 30 full time employees

6 Managing Directors (Key Functional Areas)

Forest Management• Regional Managers

• Investment Foresters

Finance and Accounting• Client Reporting• Enterprise accounting• Investment analysis and decision support

Client Service and Business Development• Sales, service, portfolio management

Economic Research – Supply, Demand and Price Forecasting

London Office


Case Study

TIMO

Manages 10 separate accounts and 5 funds

Investment strategies focus on different regions depending on the investment objective

Separate accounts have been structured as LPs and LLCs; funds have been LLCs, LPs and private REITs

Currently manages assets in all major U.S. markets and Latin America (i.e., Brazil)

Certification: SFI in the US and FSC in Brazil

Member of National Council of Real Estate Fiduciaries (NCREIF)

• Timberland Subcommittee

Two separate accounts and one fund have gone through a complete “round trip”

• Investment• Management period• Total liquidation


Case Study

TIMO

One domestic separate account client wishes to expand its exposure to the asset class but several “smaller” investors are interested in a fund solution

While the focus in the past has been the return and diversification benefits of the asset class, concern about rising interest rates has directed more attention to timberland’s inflation hedging characteristics

Additionally, the London office has identified interest among European investors in assets that can offer yield (especially given low fixed income returns)

A number of the more environmentally-conscious investors are increasingly focused on the carbon benefits of timberland investing

Alignment of interest has been a concern to many investors and they increasingly want the manager to co-invest to have “skin in the game”


TIMO Case Study

Questions to Consider

• Would you consider offering a fund vehicle?

• What is the advantage of taking this route?

• What are the risks?

• What key considerations would be important given the current investment climate and prevailing marketplace circumstances?

Thank You

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