Outlook 2025: Infrastructure to power ahead?

As inflation took off two years ago, rising interest rates put infrastructure valuations under pressure, though their inflation-proof qualities simultaneously proved their resilience. According to the Cambridge Associates Infrastructure Index, over the past 10 quarters private infrastructure experienced only one negative quarterly return, compared with four for global equities and six for global bonds.

Now, with falling interest rates and accelerating GDP growth, infrastructure moves into 2025 with a strong economic backdrop. And with the possibility that valuations have found a floor, the outlook is promising.

“Multiples may have found a floor and, with interest rates falling across the developed world, we expect them to move higher in 2025”, says Aizhan Meldebek, global infrastructure strategist at Macquarie Asset Management, in infrastructure outlook report. “Robust GDP growth should also boost earnings, making for a positive total return picture.”

Meldebek anticipates that infrastructure will generate returns in the “in the 11-12% range next year”.

Will this lead to higher fundraising levels next year? According to Preqin’s most recent report, the asset class “has endured a prolonged slowdown in fundraising since the beginning of 2023, amid elevated interest rates”. But this also came off the back of an enlarged volume of capital raised in 2022 (US$136bn), which Preqin says “helped fulfill investors’ allocation ambitions”. About $70bn was raised in the first three quarters of 2024, nearly three quarters of the $95bn raised in the whole of 2023.

Meldebeck expects fundraising to pick up, “driven by existing investors increasing their allocations as well as the expansion of the investor base”. She cites an annual survey by Hodes Weill which suggests investors increased their target allocations by 42bps to 5.5% this year. “The average investor is still 123bps below their target,” she says.

Falling interest rates should also boost transaction volumes and M&A activity. Charlie Garrood, global head of infrastructure, M&A and transaction solutions at Aon, says: “Further reductions in interest rates will help narrow the remaining valuation gap between buyers and sellers, which will drive an increase in M&A deal volumes.”

By the end of the third quarter of 2024, infrastructure deal activity by value stood at around 65% of full-year levels in 2023. As interest rates fall, Meldebeck expects infrastructure deal activity to “pick up pace in 2025, particularly in geographies characterised by strong policy support, transparent regulatory frameworks and solid economic growth”.

And while stabilisation of interest rates and valuations will help the infrastructure market in 2025, existing structural trends, such as the global energy transition and digitalisation, will continue to provide fuel to the growth of the asset class.

“Infrastructure is entering a defining age due to both external and internal forces. In 2025, we will continue to experience – and be surprised on the upside – by the rapid digitalisation of our societies and the acute need for enabling digital and power infrastructure,” says Tania Tsoneva, head of infrastructure research at CBRE Investment Management. She expects double-digit growth in battery energy storage and significant expansions in data centre capacity.

The emergence of generative artificial intelligence (AI) has brought about “the start of a new cycle of technological innovation that will span several years”, writes Nils Rode, CIO at Schroders Capital, in a 2025 private markets outlook. “We expect its impact to be as significant as, or even greater than, previous technological disruptions such as the personal computer, internet and smartphone.”

“The accelerating global energy transition and the pressing need for decarbonisation… are driving a constantly evolving set of opportunities across an increasingly diverse range of sectors and asset classes,” says Edward Mountney, an investment manager at Foresight Group. “We see significant potential across energy transition and renewables, the circular economy and other low-carbon and sustainable solutions.”

Politics will prove pivotal

Then there is the role of governments. As Hugo Llewelyn, CEO of Newcore Capital, observes: “Governments in developed countries will continue to face budgetary constraints, having to balance levels of taxation and spending that are palatable to both voters and bond markets – who both have very different priorities – with the needs of an ageing population. This somewhat bizarrely actually creates a tailwind for private capital to invest in assets crucial to the orderly running of society. The need for private investment is urgent, in partnership sometimes with government.”

This is likely to play out differently in each of the key developed geographies.

In the UK, a new Labour government is struggling to contend with stretched public finances and slow growth, while attempting a dramatic overhaul of the country’s crumbling infrastructure. Proposed solutions were set out in the Autumn Budget, including a National Wealth Fund, which will “invest in the industries of the future from gigafactories, to ports to green hydrogen”, and an Office for Value for Money.

“Will it work? Possibly”, says Perry Noble, head of infrastructure at Federated Hermes. “Those infrastructure sub-sectors prioritised by Government align with strong market tailwinds and there is capacity to scale – renewable energy, data centres and next-generation batteries. Government can focus on its core political role – stakeholder management to unlock new projects in the public interest – and can leave efficient capital allocation to investors.”

The UK’s objective of achieving a net-zero power network by 2030 is “ambitious” in his view, but removing the ban on onshore wind and proposed changes to the National Planning Policy Framework and the regime for ‘nationally significant infrastructure projects’ “have potential to be genuine solutions”.

Mountney welcomes the renewed emphasis on renewables, including the creation of clean-energy investment company Great British Energy (GB Energy), but he still has concerns. “Some of the finer details of Labour’s net-zero strategies – for example, the exact role that GB Energy will have to play, strategies to manage grid capacity queues/congestion, and clearing major bottlenecks to achieving a cleaner energy network – are not yet clear.”

Given the chequered history of private capital investment in UK utilities, Llewelyn makes another crucial point. “Owing to the importance of social and economic infrastructure to people’s everyday lives, it is vital that investors entering the sector do so in a sustainable – in all senses, environmentally, socially and financially – manner,” he says. “This means using appropriate levels of gearing, a moral approach to tax, no performance fees for taking core risk, and a disciplined approach to capex and reinvestment.”

There are also promising tailwinds in the EU, as regulators and lawmakers seek to further boost renewables investments. This was evidenced by the ambitious Renewable Energy Directive III, which provides a legal framework for the development of clean energy across all sectors of the EU economy.

In Germany, the government has proposed changes that would allow pension funds to increase their allocations to infrastructure. “Pension funds may soon allocate additional capital in energy transition assets thanks to a new separate 5% infrastructure quota,” says Nicole Arnold, member of the board of Commerz Real.

She also highlights “hybridisation and repowering”. An increasing number of operating wind and solar assets in Europe will reach the end stages of their envisioned life cycles, putting repowering replacement schemes on the agenda. Hybridisation, coupling two complementary green energy sources and/or storage capacity, can help streamline energy production and thus yields, while using grid capacity in a more efficient manner. “This should also further enhance the growing momentum of BESS [battery energy storage system] integration in renewables investments,” she says.

However, as in the UK, Pieter Welman, head of global infrastructure at Barings, warns that “the current political challenges in Europe might mean that 2025 would be too early for many deals to close”. By contrast, he says, the US will “continue delivering more deal flow than Europe in 2025, largely driven by a strong economy, and we expect M&A activity in particular to rebound”.

But with Donald Trump to replace Joe Biden as the US president in the new year, politics will become pivotal for infrastructure investors. “The political certainty following a busy election year, easing inflation and gradual interest-rate cuts set a positive tone for a continued revival in infrastructure M&A and capital flows,” says Tsoneva.

However, there is uncertainty over the future of Biden’s 2022 Inflation Reduction Act (IRA) of 2022, which saw investment in clean energy increase by 43% relative to the two preceding years, with solar and storage investments increasing 56% and 130%, respectively. Meldebeck believes “it is unlikely for the IRA to be fully repealed”. But investors might want to note the use of the word “fully”.

“In the long term, there is increased uncertainty around what may happen to the tax credit sections of the IRA,” says Corey Lewis, managing director in the transaction solutions team at Aon. “The sponsors/developers in the renewable-energy sector that we work with are carrying on with their expected pipeline over the next few years for the time being. In the US renewable-energy sector, it is business as usual entering 2025 for sponsors/developers either lining up tax equity investors and/or finding tax credit buyers and building projects.”

Energy transition will be the dominant theme in 2025. “Opportunities are expanding beyond energy generation alone,” says Don Dimitrievich, portfolio manager for energy infrastructure credit at Nuveen. “Areas such as energy efficiency, storage, grid enhancements and infrastructure supply chain investments offer appealing investment opportunities.”

For the past two decades, power demand growth in the US has remained relatively flat, but this could be about to change. “We are now witnessing a paradigm shift, with demand accelerating dramatically,” says Dimitrievich.

“The surge is driven by the rapid expansion of generative AI and cloud-storage data centres. This historic increase in power consumption is set to catalyse the entire power generation landscape, with significant buildout of renewables, conventional powers, and even small modular nuclear power announcements.”

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