LAND JOURNAL

Impact investment: valuing natural assets

Everyone is talking about natural capital, but how can you viably put a price on nature?

Author:

James Cairns

23 March 2019

The basis of the natural capital thesis is sound: by putting a price on nature, you can use this to attract the investment and regulatory protection that other forms of capital are able to attract. But the reality is that you can only price natural assets if there is a market willing to pay to protect or use them.

At Mopane Capital it is our view that a realistic and credible way to value nature is to securitise the asset so it can be represented on the balance sheet and traded. That means valuing natural capital in a tangible way connected to the underlying asset – land.

The key questions then are as follows.

Who is the market?
How can this work?
Does this still account for the intrinsic essence of natural capital?

Impact investment

Impact investment is a growing asset class that seeks to finance projects blending environmental impact, social impact or both with a subsidised financial return. Market evidence suggests that investors are willing to pay a premium or accept a lower risk-adjusted return for the natural capital features that land assets and ecosystem services provide. Such blended finance transactions currently focus on projects in developing countries, largely in the tropics, that make a social or environmental difference, or both, at scale.

The impact market is growing at an estimated 18% a year according to the Global Impact Investor Network’s Annual Impact Investor Survey 2017, and JP Morgan, with the Rockefeller Foundation, estimates that impact investments could reach $1tr in assets under management by 2020. Market participants include development finance institutions, high net worth individuals, family offices, and, increasingly, the leading investment banks, which want to be seen as part of the solution, not the problem.

The market is fundamentally driven by the need to fill a significant gap in funding for the protection and conservation of at-risk wilderness, species and ecosystems. Credit Suisse and McKinsey’s Conservation Finance. From Niche to Mainstream: The Building of an Institutional Asset Class estimates that environmental conservation projects need $300–400bn each year to preserve and restore ecosystems, but receive just $52bn, which has historically come from public and philanthropic sources. This is compounded by the fact that governments in these regions cannot continue to fund these public goods, while donations are also falling because of poor performance and accountability. Sustainable finance of natural capital is the only viable way to prevent and reverse the loss of protected area land and unique ecosystems.

In addition to yield and impact, tax offsetting, portfolio hedging and long term capital growth expectation are subliminal drivers of this market, as are intangible elements such as reputation, legacy and the intrinsic satisfaction that comes with preserving and restoring iconic landscapes and species. The market is therefore complex, as well as immature, and as such transactional activity is constrained by a lack of advisers equipped with a standardised and practical valuation model that can represent the specialised factors influencing value, risk and return for a natural capital asset in this market.

Karingani Game Reserve Mozambique

Assets and ecosystem rights include the following:

150,000ha of pristine bush in a single aggregation
land secured in 50-year + 50-year DUAT title, a state-granted land right
water rights, development rights and a tourism licence with control of the ecosystem.

Conservation and ecosystem features include:

integration with Kruger National Park and Great Limpopo Transfrontier Conservation Area
strong habitat integrity biodiversity and a frontline role in protecting at-risk rhino
baseline habitat social and game survey completed to form key performance indicator (KPI) targets.

The ecosystem business plan is based on:

high-value low-density eco-tourism development plan
investment return of up to 5% over a 15-year term
strong capital growth prospect and tax-efficient structures.

This valuation underpinned the price and supported sale of a 20% equity interest to an investor.

Market model

To bridge this gap, Mopane Capital has developed and pioneered a valuation model that appraises natural capital assets from an impact investor’s position. The model is dubbed the Natural Capital Asset Model and takes a land valuation approach with a twist for natural capital. In simple terms the approach can price a premium for the natural capital element in a land asset as an addition to, or a discount against, market value or risk.

The ultimate output is a value that underpins real-estate-based equity, debt and risk pricing and can sit fairly on the balance sheet to support transactions, decision-making and asset management. Financial accountability and established methodology underpin the viability of application, but it is the innovative classification of the relevant special value features that enables valuers to quantify a natural capital premium robustly.

Table 1.

Basis for Mopane Capital’s approach

Value/risk adjustment	Rationale	Data source	Adjustment
Scarcity	At-risk wilderness; endangered species; scale; population pressures etc.	Red List of Threatened Species; LoW map; population maps; likelihood risk	+/- ARY +/- Comps +/- PV
Marriage value	Aggregation; ecosystem integration; landscapes; economies of scale	Property assessment; trans-frontier parks; sustainable plans	+/- ARY +/- Comps +/- PV
Hope value	Supply and demand – diminishing market; market growth/maturity	Morgan Stanley Capital International (MSCI) Index, Green Bond Index, Global Impact Investing Network Index; GDP growth rates etc.	+/- ARY +/- Comps +/- PV
Ecosystem risk beta	If higher beta it is higher risk for monetising services, but it offers higher level of protection for ecosystem	Property baseline study v sample benchmark over time	Beta (X) ARY + Comps
Sustainability alpha	Measure property KPIs against UN Sustainable Development Goals (SDGs). If KPI beats benchmark index, then alpha is created, meaning positive	One Planet Index; MSCI Carbon Index; World Bank Human Capital Index (all of these are property SDG KPIs)	Alpha (X) ARY + Comps

Table 1.

Basis for Mopane Capital’s approach

Value/risk adjustment	Rationale	Data source	Adjustment
Scarcity	At-risk wilderness; endangered species; scale; population pressures etc.	Red List of Threatened Species; LoW map; population maps; likelihood risk	+/- ARY +/- Comps +/- PV
Marriage value	Aggregation; ecosystem integration; landscapes; economies of scale	Property assessment; trans-frontier parks; sustainable plans	+/- ARY +/- Comps +/- PV
Hope value	Supply and demand – diminishing market; market growth/maturity	Morgan Stanley Capital International (MSCI) Index, Green Bond Index, Global Impact Investing Network Index; GDP growth rates etc.	+/- ARY +/- Comps +/- PV
Ecosystem risk beta	If higher beta it is higher risk for monetising services, but it offers higher level of protection for ecosystem	Property baseline study v sample benchmark over time	Beta (X) ARY + Comps
Sustainability alpha	Measure property KPIs against UN Sustainable Development Goals (SDGs). If KPI beats benchmark index, then alpha is created, meaning positive	One Planet Index; MSCI Carbon Index; World Bank Human Capital Index (all of these are property SDG KPIs)	Alpha (X) ARY + Comps

Note: alpha and beta returns are adjustments relative to index
Key: ARY = all-risk yield; Comps = comparables; LoW = Temporally inter-comparable maps of terrestrial wilderness and the Last of the Wild; PV = present value

The first step in the valuation process is to understand and review the fundamental criteria that must be met to securitise and attract capital. These are based on impact investor criteria and can be defined as:

land tenure and control of ecosystem rights to provide security
ability to monetise the asset or ecosystem services for a risk yield
upside from tax offsetting, portfolio or capital growth strategy
measurable and positive environmental and/or social impact
good corporate governance, management and compliance
landscape-scale approach with integrated ecosystem and social inclusion.

"It is the innovative classification of the relevant special value features that enables valuers to quantify a natural capital premium robustly"

If an asset meets these triage criteria then investors can engage and the model can work. The downside to this approach is some private and public goods will be missed; however, what can be valued will be robust and has a good chance of achieving sustainable economic success. The inconvenient truth is we cannot save the whole planet – but where these criteria are met, we can make a difference

The next step is to quantify the special natural capital attributes. It is essential to inform these adjustments using as much quantitative data as possible to minimise subjectivity and provide a rigorous rationale. This needs to be done at the level of the individual asset and then benchmarked against the relevant market and property indices that are available. However, data is still limited, and an element of valuer skill, judgement and experience is needed.

The final process is to fold the natural capital analysis into the valuation approaches to reach a robust weighted value reflecting the natural capital premium in the final asset value. The mechanics behind this are currently based on Mopane Capital’s proprietary model and market experience.

This model is not suitable for all natural capital situations; however, in our view, where criteria are met, it does offer a rationale for the sustainable financing of natural capital assets. The bottom line is that natural capital value is ultimately what the market is willing to pay to save it. Impact investors have paid a premium or accepted a risk-adjusted return to protect and restore natural capital-based land projects. That is powerful, but the market is still immature and it is our opinion that, we, as a profession, could adopt this as a standard model to drive market activity and enable investors, stakeholders and governments to unlock finance for protecting these special assets.

James Cairns is founder and CEO of Mopane Capital jc@mopanecapital.com