Reprinted from Private Equity International
by Christopher Witkowsky, Editor
A Baltimore-based investment firm has raised $180 million to invest in wetlands restoration, a niche strategy that combines conservation with mid-teen return expectations.
Most limited partners probably would not associate private equity with the restoration of rapidly disappearing swampland in the backwoods of southern Louisiana. But one firm has taken on that job – and plans to invest in the land through a private equity fund.
Ecosystem Investment Partners, based in Baltimore, Maryland, has closed its second fund on $180.7 million for investments in the restoration of wetland properties. The firm used Monument Group as placement agent for the fundraising.
The firm managed to sign on a traditional mix of private equity LPs, including public pensions, endowments and high net worth individuals, who were attracted to the midteens return potential and the eco-friendly nature of the opportunity.
“The strategy is a niche strategy that does not have a lot of competition and thus holds out the possibility of attracting risk-adjusted returns,” according to Bob Jacksha, chief investment officer of the New Mexico Educational Retirement Board. The retirement system committed $30 million in 2010.
“Also, the performance of this strategy is expected to have a low correlation with the majority of our other investments,” Jacksha told sister publication Private Equity International in a recent interview.
How it works
So what is the money-making potential here? The firm, formed in 2006, identifies former wetland properties that have been drained and developed that it believes it can return to their native swamp states. The purpose of this is to secure credits from the federal government, which the firm then sells to developers who want to develop other wetland properties.
Wetlands are protected from development under various federal laws, but the US government grants exceptions to developers to build on wetland properties as long as they demonstrate their need to encroach on protected lands is unavoidable. As part of the exception, they have to restore equivalent acreage somewhere else. For example, a developer who is granted a permit to build on 50 acres of swamp will have to restore another 50 acres elsewhere.
To meet that requirement, developers can do it themselves, or they can purchase credits from investors who already have a portfolio of restored wetland properties, and that is where Ecosystem Investment Partners comes in.
The firm, through its second fund, plans to buy 10 to 15 US rural properties, ranging in size from 1,000 acres to 10,000 acres and priced between $5 million and $20 million. It then works to get the property certified as a “mitigation bank” by the US government, which then qualifies it to generate credits once the wetlands aspect of the property is restored. After the restoration is complete, the government will release the mitigation credits to EIP, which is then free to sell them at a profit.
EIP has already made one investment from the second fund. It acquired 3,860 acres of mixed pine and hardwood timberland in southwest Louisiana in September 2011 for a project it calls Calcasieu Pine Savanna. The firm is in the process of getting the property certified as a “mitigation bank”. Restoration work on the property would take several years, according to Nick Dilks, managing director with EIP.
Risk and reward
The risk in this strategy is in the choice of appropriate properties to restore, Dilks said. If for some reason the firm cannot restore the property back to wetlands, it won’t collect credits from the government and will lose out on any profits related to their sale.
“You’ve really got to know these sites. That’s part of the value we add … you have to be very careful in selecting just the right properties with the right restoration attributes,” Dilks said. Potential obstacles could arise, for example, in restoring properties surrounded by developments where the neighbors wouldn’t appreciate a return of wetlands that get their own residential properties wet, he said.
“The credits are only released upon finishing the restoration, so if you’ve bought the wrong property, there could be a high risk,” he said. Return expectations for this type of strategy are in the mid-teens, Dilks said, which is in line with general real assets strategies like timber or agriculture investments. The strategy also comes with a current income aspect, as the firm is able to make distributions to LPs as it sells credits, he said.
Like other real assets strategies, LPs hope to get a decent return with some liquidity protection. In the case of EIP, though, LPs like endowments also get a sense of “mission”, something becoming more important to certain institutions, Dilks said.
Conservation can be seen as a “mission”, but EIP’s strategy is one that focuses on returns as well. “LPs aren’t interested in sacrificing returns,” he said.
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