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The Investment Value of Ecosystem Condition

Like it or not, expressing nature value in dollars may be the best indicator

The article was titled "Scaling Financial Investment into Natural Capital". I read it, scratched my head, then re-read it.

Scaling Financial Investment ......πŸ€”. Written by a biodiversity credit developer the article doesn't cover scaling financial investment into natural capital. The post is about ecosystem condition and their framework and accreditation for assessing ecosystem condition, not how ecosystem condition (EC) drives or is expected to scale natural capital investment.

Of course ecosystem condition and function is what the real work of nature conservation and restoration is about. And an accredited methodology for assessing EC is awesome. But I think the article meant to say or at least imply that ecosystem condition is valuable and should be financially invested it.

But I hate to say it:

Money doesn't care about ecosystem condition, it cares about money.

Frankly ecosystem condition will not drive nor scale nature investment unless it tied to and expressed in financial terms.

Natural Capital Indicators

Let's pretend you are a nature or climate investor or a brand looking to reduce nature related risks and dependencies or even a conservationist. (Note that I did not even speculate that a financial investor is even thinking about this stuff.)

Ready?

Now which statement below helps you make the most effective decision when assessing a nature investment into a project like this 41 acre mixed forest, wetlands, & cropland natural capital asset?

A) The overall ecosystem condition is 8 of 10.

B) The annual value of the ecological benefits of this site is $415,569 and produces a 122% annual return on natural capital. The primary natural capital values from this real asset are recreation, habitat, resilience, pollination, clean air, water abundance, erosion control, clean water, climate stability, and healthy soils.

C) Soil organic carbon is 2.5 tons per acre. Biodiversity intactness is 85%. Pollinator diversity includes 30 different species. Phylogenetic diversity is high. Local nature access is .8 acres per person. Water stress index is 0.6.

D) The intrinsic value of this site is priceless and infinite.

Which did you choose?

Of course there is no wrong answer. They all say the same thing just in different ways. The main difference is how indicators are expressed: (A) is an ecosystem condition score, (B) uses the RealValue of Natural Capital framework, (C) expresses several ecological metrics and indicators and (D) needs no explanation.

But which one helps you make the best investment decision?

Scaling Financial Investment into Natural Capital

If we are really to scale financial investment into nature and biodiversity we must speak the language of finance and use financial metrics and indicators.

In this context, the answer I choose is (B): The annual value of the ecological benefits of this site is $415,569 and produces a 122% annual return on natural capital. The primary natural capital values from this real asset are recreation, habitat, resilience, pollination, clean air, water abundance, erosion control, clean water, climate stability, and healthy soils.

Despite concerns about financializing nature this does not prevent any of 250+ ecological and biodiversity indicators being paired with the financial indicators. In fact this is what should be done as part of any natural capital valuation to arrive at a quantitative and qualitative, holistic value.

Under a combined approach we could easily add (A), (C) and (D):

We recognize that the value of nature is infinite and the benefits it provides as priceless but that dynamic valuation helps protect and restore that value. The annual value of the ecological benefits of this site is $415,569 and produces a 122% annual return on natural capital which is based on an ecosystem condition score of 8/10 and these metrics: Soil organic carbon is 2.5 tons per acre. Biodiversity intactness is 85%. Pollinator diversity includes 30 different species. Phylogenetic diversity is high. Local nature access is .8 acres per person. Water stress index is 0.6.

But what does this look like in practice?

How Ecosystem Condition Affects Investment Value

Protecting and restoring ecosystems takes money. And in modern society with ecosystems being embedded in real assets it takes lots of money. Real assets including land and infrastructure are the most capital intensive assets.

Again: To scale financial investment into nature we need to speak the language of finance: money.

The quickest and most effective way to do this is to use the RealValue of Natural Capital framework and the Natural Cap Rate.

I am not going to explain the full framework, as you can review it here. All you need to know for this example is how the relation of the stocks and flows of natural capital work. STOCKS are the ecosystems contained within a real asset. FLOWS are the annual ecosystem service values (ESV). Both stocks and flows are expressed in $'s. A Natural Cap Rate is the relation of annual flow value divided by the real asset value, expressed as a percentage.

It is our thesis that a society which truly values all types of capital will emphasize and prioritize a natural cap rate of 100%. A 100% natural cap rate means that ecological value is respected and in harmony with financial and economic value and thus reflected in real asset value (land and real estate prices).

To show how ecosystem condition affects investment value we can easily run two models:

  1. FLOWS: model the ecosystem condition rating to see changes in natural cap rate.

  2. STOCKS: model the natural cap rate at 100% on #1 to see changes in real asset value.

For the modeling we will use the the same 41 acre mixed ecosystem asset which is from a real Natural Capital Valuation we just completed for a landowner in the Midwestern US.

Base Model

The subject site appears to be well stewarded by a knowledgeable and thoughtful owner and we rated the overall ecosystem condition as an 8 of 10. Based off of existing conditions we treat this as the baseline.

Natural Capital Valuation

41 acre mixed forest (27%), wetlands (54%), & cropland (19%) in the Midwestern Tallgrass Prairie & Forest Transition Bioregion

FLOWS: $ 415,569

STOCKS: $ 340,000

Natural Cap Rate: 122%

Relational Value of Natural Capital

FLOW Model

For this model we will change only the ecosystem condition rating (EC). Changing the EC changes the line item values of the Core Benefits. In this model the STOCK value remains a constant as it is based on the real world real asset market value of $340,000.

(Note that RealValue is a meta-analysis value transfer method that uses EC as a multiplier against the Core Benefit dollar values based on land cover and derived from thousands of ESV studies.)

Ecosystem Condition Change

Core Benefits of Natural Capital Values Based On Ecosystem Condition

The changes in values due to ecosystem condition are notable. For me, one of the biggest takeaways this that current real asset appraisal practice does not even consider ESV and effectively treats ecosystem condition and function as $0 value (unaccounted column).

Effects on Natural Cap Rate

The natural cap rate is directly tied to ecosystem condition. This is based on movement in the dollar value of FLOWS due to change in EC.

Value Change Due To Ecosystem Condition

Intuitively I think most people understand that when the natural environment is in better condition it is more valuable. RealValue helps us quantify that value in a common language: dollars.

Of course FLOW value is not income or cash flow (yet). If we do our jobs right with Ensurance, a % of FLOW value will become financial value. For the time being how does EC get translated to real value in the real world? In the real asset value.

STOCKS Model

We all know ecosystem condition has value but how to best express that value has been the challenge. RealValue quantifies the natural capital value in dollars based on ecosystem condition.

The real world values the subject asset at $340,000 (market value). RealValue shows us that the market is leaving money on the table by not properly valuing the benefits nature provides.

Current appraisal practice (which leads to market value) places the highest value on "improved" properties (human use). Undeveloped land is considered "unimproved" and is typically valued based on comparables. Through this lens appraisal practice ignores the value of the ecosystem services and the land is effectively undervalued.

Natural Capitalization

When the ecological benefits are properly valued and capitalized the RealValue is $415,569 as opposed to $340,000. This is $75k of value the market has failed to realize. I personally put this in the externality category.

What could you do with an extra 22% ($75k) of value? Put nature on your balance sheet? Sell some of that value? Borrow against that value? Manage your land/ecosystem differently to steward and increase that value?

Of course we need the market to recognize the unaccounted value and that is the work BASIN has set out to do. It is our belief that the common adage of "What gets measured gets managed" will ring true when people grasp that the dollar values on paper closely align with the way a place feels and looks.

Effects of Ecosystem Condition on Value

After the natural asset is properly valued and capitalized we can make an even comparison on ecosystem condition alone.

The table shows the effects of ecosystem condition on value as compared to baseline.

If the subject asset stewardship was improved there is at least another $100k of value (and this is on top of the $75k that the market is ignoring). Conversely, if a use change decreases the ecosystem condition so does the $ value. To me, the value of both conservation and restoration are evident and easily understood via these financial indicators.

Practically and intuitively we also know that the current market value would change based on land condition i.e. the market value of $340k would be less or more based on the state of the land. The method we propose here is not different from normal market behavior, it is just more detailed and accounts for the other benefits that the market is overlooking.

Financial Indicators v. Ecological Indicators

Expressing nature value in financial terms does not negate or diminish the importance ecological indicators. This is not an either/or, it is and/both. Financial indicators and ecological indicators used in concert with each other will help bridge the instrumental value to intrinsic value gap to make nature investable. Or in other words: Scale Financial Investment into Natural Capital πŸ˜‰

How Can This Help You?

If you are a land owner or real asset investor, being able to see how land and ecosystem condition affects dollar value is a powerful tool regardless of your goals as a real asset owner. If you are land steward or conservationist, RealValue helps show the value of your work and can be combined with other ecological indicators to communicate your impact.

Future posts will delve into the value of restoration, the value of conservation, and how to make money investing in nature. We will also, of course, cover how to convert value to income via Certificates of Ensurance.

To get a natural capital valuation on your real asset or to dive in to these concepts please contact Thomas Morgan, CCIM at 1-970-618-4086.

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#nature finance#investing in nature#ecosystems#ecological value#ecological indicators#ecosystem condition#natural capital valuation