What Germany’s €500bn plan could mean for infrastructure investors

Late last week, Friedrich Merz, soon to become Germany’s next Chancellor, confirmed the market’s best hopes with a €500bn fund to invest in defence and infrastructure. The balanced budgets associated with Germany since the completion of the country’s reunification are being jettisoned in a bold move designed to revitalise the nation’s infrastructure, bolster defence capabilities and stimulate economic growth.

Infrastructure investors universally welcome the programme. “As anyone who has travelled by train in Germany recently can attest, there is a huge need for infrastructure spending, so the announcement of a large increase in government-funded infrastructure investment is very welcome news” says Graham Matthews, head of fund management infrastructure at Augsburg-headquartered real assets investment manager Patrizia. “Across transportation, utilities and other critical sectors, decades of fiscal restraint have led to underinvestment, in some cases to the point of breaking point.”

Indeed, Detlef Schreiber, CEO of Hamburg-based renewable-energy investment specialist CEE Group, says he doesn’t “know any infrastructure players who are opposed to the general rationale behind this plan”. He adds: “The proposal marks a sea change in the investment environment for infrastructure in Germany and Europe.”

In fact, so much investment is needed, it is a question of where to begin for the €500bn Sondervermögen, or ‘special fund’. Peter Brodehser, partner for infrastructure investments at DWS, says: “The financing needs are enormous. In fact, I think that the €500bn will hardly be enough to cover the current financing needs.”

Micheal Steingold, director of private markets at Russell Investments, agrees. “There is a lot to do in the German economy. This is the first meaningful fiscal expansion in German infrastructure asset class history. This is essentially ‘reindustrialisation’ and we think is going to be very meaningful because we just haven’t seen this type of approach before. And we’ve just seen how well it works in the US with the [Inflation Reduction Act] and the Infrastructure Bill. We think there’s a great parallel to what can happen in Germany. And so, we know what a game changer this type of fiscal stimulus could be.”

Where will all this firepower be directed? “This package will drive key megatrends such as decarbonisation, digitisation and energy transition,” says Matthews. Energy will be a clear beneficiary, not least since geopolitical risks, including the Ukraine invasion and the Nord Stream attacks, have highlighted the urgent need for energy security. “A major focus will be upgrading electricity grids – not just cables, but also transformers and substations – to connect renewables, enable EV charging and support battery energy storage,” he adds.

There are so many projects that could be the target, says Brodehser. “Power grids are literally falling through the cracks in their search for financing,” he says. “They are only attractive to institutional investors who can live with a single digit and back-ended return. And the liquidity of this investor group alone is simply not sufficient to cover the high investment volumes. This is where the government’s Sondervermögen kicks in very usefully and can finance precisely these projects.”

“Governments alone cannot fund the infrastructure Germany needs”

Graham Matthews

Michael Pfennig, co-head of infrastructure equity at Allianz Global Investors says: “A large part of Germany’s infrastructure was built after the Second World War and needs to be renovated and modernised.” He says that, “by far the highest investment requirements”, will be in “the modernisation of the energy infrastructure to drive decarbonisation”.

Venture capital for clean-energy start-up firms involved in the area of clean energy could be another potential provision of the programme. Pfennig says: “European cleantech companies have been suffering from a lack of scale-up capital – in particular, with respect to the support of new business models in the area of decarbonisation, such as green molecules, which are at an early stage of development and require time to achieve economies of scale to become competitive against fossil-fuel alternatives. Public support can accelerate this development.”

Given the potential scale of defence spending, there could be opportunities related to army barracks. “In the US, a lot of military housing is run by private housing providers,” says Steingold. “That’s a model that gives Europe the type of scalability that they need.” And he anticipates wider potential opportunities across social infrastructure such as healthcare and education.

The need for private capital

Politicians are taking the lead in investment, but what about private capital? “Governments alone cannot fund the infrastructure Germany needs,” says Matthews. “Private capital will be essential.”

Pfennig welcomes the lead the government is taking, but he says: “We think that public money can play a vital role to establish partnerships between public and private capital for very large capex projects – like for the build-out of electricity grids, which require tens of billions of new equity capital. Such new partnerships can make large-scale projects investable, crowd in private capital to better lever public capital and reduce overall financing costs for the benefit of the consumer.”

Fortunately, recent regulatory changes allowing German pension funds to invest more in infrastructure could contribute to bridging that gap. Europe has a large pool of institutional capital estimated at around €15trn, of which only 3-5% is invested in infrastructure. This compares to around 10-15% for example in Canada.

“Mobilising this pool of capital to modernise critical European infrastructure would be a win-win for policyholders looking for stable, cash-yielding and inflation-linked returns as well as governments, as critical infrastructure would be funded by competitively priced long-term and like-minded capital,” says Pfennig.

That this initiative is coming just a few weeks after the pension fund reforms is “one of the key reasons why the package is a real game changer”, says Steingold. If the infrastructure programme was to lead to a series of public-private partnerships, he says, the beneficiaries would be “the companies who already have operational capability and crucially the growth skillset – and that is pretty squarely in the private-equity infrastructure strike zone”.

However, as Claus Fintzen, CIO for infrastructure debt at Allianz Global Investors, says, “a large number of infrastructure sectors are already well served by the private sector”, including “established technologies in renewables, transportation, energy and digital infrastructure, and public-private partnerships”. He says: “These transactions are profitable, and risks are clearly defined.” For example, Allianz finances hybrid trains in the north of Germany, replacing old diesel trains which are leased to the operator with the support from the public sector. Allianz also finances roads which are refurbished and managed by the private sector.

So where would more public-private investment be needed? “Where we do expect more activity [is in] sectors which require government support”, Fintzen says. “This could be because risks cannot be fully quantified or transactions cannot be profitable on a standalone basis.” Examples are fibre network in rural areas or green molecules which do need offtake subsidies to pay for the investment and running costs.

Pfennig also sees “manifold” opportunities for private capital investments to be taken to the next level, such as the “modernisation and build-out of energy grids”, he says, citing Allianz’s existing investment in Neu-Connect, the first German-UK interconnector. Then there is the “scaling up new capex-heavy green technologies…or rollout of fibre to the home.”

Considering the new emphasis on energy security, Matthews notes Patrizia’s “investments in cavern storage for crude oil, gas and hydrogen, as well as above-ground tanks for refined products, which will play a role in securing supply chains”.

Another crucial area for him is district heating, where Germany aims to connect 100,000 buildings each year. He says: “While cities like Berlin and Munich already have strong networks, significant investment is still required.” He points to Patrizia’s Greenthesis project in Bergamo, Italy, as a template. It will provide sustainable heat to 11,000 households, eliminating 15,000 tons of CO2 per year.

Hurdles along the way

Regardless of the potential, success will depend on swift implementation and the ability to navigate potential political and economic challenges. Currently, as Schreiber notes, “it is still far from certain if the landmark infrastructure programme will materialise as advertised by Friedrich Merz and his prospective government parties”. Opposition parties have launched last-minute legal challenges.

Schreiber sees three key hurdles. Firstly, the German centre-right and centre-left need to finalise their coalition agreement, which is expected to take several weeks at least. Secondly, Germany needs to amend its constitution to relax borrowing constraints. Lastly, even with both government parties’ approval secured, they need additional votes from the Green party because the changes to the German constitution require a supermajority.

And, if it does pass, there will be hurdles to deploying capital fast enough. “The challenge now is ensuring fast and efficient capital deployment, overcoming bureaucratic and supply-chain hurdles, and enabling public-private collaboration,” Matthews says.

Fintzen also notes: “Planning processes in Germany very often take too much time. A public procurement programme will usually take years before the first euro is going to be invested.” He also worries that “municipalities are not really set up to run large procurement processes, so they will require consultancy support helping to define and structure efficient partnerships between public and private”.

But, if successful, the programme could have wider knock-on effects for European infrastructure. “Germany historically has been the limiting factor on other countries’ abilities to do these types of transformational stimulus packages,” says Steingold. “If you now have Germany leading in this way, we think that might open up the opportunity for other economies.

Across Europe, borrowing markets are pretty liquid for other countries as well. This does feel like a really interesting moment in time. The political headwind that had been there for the last 20 years is now going away because the Germans are leading.”

To read the latest IPE Real Assets magazine click here.