Biden’s once-in-a-generation infrastructure plan puts infrastructure investment trusts in the spotlight. Fraser Hughes and Ben Morton report
There is no shortage of capital for infrastructure but rather a lack of suitable investment vehicles and political will. So another way forward is necessary.
A mammoth investment step-up to modernise the country’s infrastructure, creating millions of jobs is in the process – this was how the Biden administration billed its American Jobs Plan, after weeks of negotiations led to an agreement among a bipartisan group of US senators in June. The president sees the infrastructure deal as a catalyst for a clean-energy future.
This deal is a huge step towards addressing the nation’s ageing infrastructure, but much remains to be done over the long term, as highlighted by the latest American Society of Civil Engineers (ASCE) 2021 infrastructure report card.
The ASCE reports that for the first time in 20 years progress has been made in restoring the country’s infrastructure, taking US infrastructure out of the ‘D’ range to ‘C-’. The country is moving in the right direction in sectors like drinking water, inland waterways and airports, and the private sector has invested in the electric grid, rail, and more.
The ASCE’s analysis reveals that the US long-term investment gap continues to grow. Table 1 shows that the total investment required over the next 10 years has increased to $2.59trn, from $2.1trn in 2017 – the US is currently paying about half of its infrastructure bill.
What is needed is more long-term, consistent investment from government and the private sector, equivalent to 3.5% of GDP by 2025. Continued underinvestment at current rates will have serious economic consequences, the ASCE argues, costing an estimated $10trn (€11.7trn) in GDP, more than 3m jobs, and $2.4trn in exports over the next 20 years.
There are benefits in introducing a clearly defined Infrastructure Investment Trust (IIT). The development of an IIT structure, tax-efficient both for governments and investors, would aim to create a financing tool for essential but costly long-term generation-to-generation infrastructure. The proposal, at a time when the funding of public projects is under extreme pressure, offers a potentially harmonious social outcome where citizens get quality infrastructure assets and services; politicians get happier voters, job creation and an economic boost; and a wider range of willing investors get access to infrastructure assets.
A G20/OECD report published in July 2020 presents multiple proposals from the private sector on mobilising investment in infrastructure, including one on a clearly-defined financial vehicle for infrastructure – an IIT – for which GLIO provided the OECD with comments and feedback.
The IIT structure could emulate the legal and financial blueprint set by REITs. It is worth reminding ourselves that in the US, where REITs originated, there are six vehicles backed by infrastructure assets that are predominantly telecom towers. Today about 25-30% of all commercial real estate is in the hands of private investors through the $1trn REIT market. NAREIT estimates that 80m Americans own REITs through retirement savings and other investment funds.
Hurdles and solutions to an IIT
A Cohen & Steers paper in 2020 examined the weight of investment dry powder awaiting suitable infrastructure assets. It concluded that while governments struggle to raise capital to maintain or develop essential infrastructure, $220bn in potential investment is seeking a home. Clearly the shortage is not of capital but of the willingness of governments to work with the private sector and to create suitable asset vehicles.
North America has a rather short track record in transportation infrastructure. Toronto’s Highway 407 is a positive example that has supported $16bn in economic benefits for the area since it was sold 20 years ago, but the privatisation of transportation assets is rare. In the ASCE report passenger railroads scored ‘D-’ and airports scored ‘D+’, which tells a similar story of under-investment and limited private-investment involvement.
We believe that innovative and case-supported privatisation programmes can provide the mechanism to address the mismatch between capital poised to invest and public assets in need of upgrading.
The biggest hurdle, however, is politics. Getting state and local lawmakers to release ownership and control of critical assets to private companies remains a challenge. Moreover, voters may need convincing that the aim of the privatisation is not profiteering but funding the building and management of costly yet essential transport and communications infrastructure.
Another issue lies in the provision of assets in less-densely-populated areas. The need for infrastructure maintenance might be acute but expected user fees might not provide a feasible investment case.
The advantages to those with greater infrastructure awareness are nevertheless clear:
• People get to use higher-quality, better-funded assets and services than they would otherwise. This is particularly pertinent post-COVID, in a world where global government finances are stretched by the attempt to reboot the economy;
• Updated infrastructure fuels an economy’s long-run potential growth rate and competitiveness;
• A broader range of investors get access the infrastructure assets they crave in a coherent, transparent and regulated vehicle. Put simply, the population can own a stake in the essential assets they use on a day-to-day basis;
• Factoring ESG considerations into the development and maintenance of assets is critical to receive funding from private markets –investors must be convinced those managing the assets are doing the right thing. There is a opportunity to ring-fence essential new clean-energy development. The cost of doing nothing could be huge. The risk of continued inaction is obvious.
Creating an IIT structure against a backdrop of pent-up global demand for targeted infrastructure investment could open the floodgates to private capital. Conditions would be set to attract investment to mission-critical transportation and utility infrastructure assets, many of which are in dire need of improvement.
For investors, the steady cash flow of infrastructure projects would also mean that the IIT could be used as part of a stable, lower-volatility, high-yield investment allocation. This type of asset class is in high demand by investors.
Boosting the tax base with IITs
The introduction of an IIT should act to increase the tax base. Currently, publicly owned infrastructure competes with private business but is not part of the tax pool – that is, private airlines versus government-owned rail.
If owned privately, these assets could then contribute to the tax base – for example, in the case of an airport, states and municipalities could benefit from an increase in property taxes, while dividend payments and capital gains could also be taxable. The creation of an infrastructure investment vehicle could be a net addition to the existing tax base rather than a tax burden.
A purpose-built IIT could leverage much of the success offered by other tax-efficient structures like REITs and provide a defined path for inward-bound infrastructure investment.
The IIT could be tailored to the characteristics of infrastructure assets, including how assets and income qualify for inclusion. For example, looking at the ASCE breakdown of infrastructure types, sectors such as transportation, energy and communications naturally lean towards private investment, while social infrastructure such as schools, public parks and recreation lean towards government funding.
Looking at the funding gap, imagine how private finance could help develop transportation ($1,619bn gap to 2029) while the government redirects resources to the $490bn gap for US schools. This is public and private capital working together for the greater good.
Table 2 outlines the basic elements of a purpose-built IIT. This definition would cover the ownership of electric, gas and water utilities, energy transportation and storage, telecommunications/data physical architecture, freight and passenger railways, airports, seaports, bridges and toll roads.
Much of global infrastructure investment requires new construction projects, both in developed and emerging economies. This involves a period of no income and, in fact, losses from up-front investment.
An IIT would need to capture the tax loss pass-through benefits of a private partnership structure, unlike the current REIT rules, providing a powerful investment incentive from a broad base of long-term global investors. The 1980s construction boom in commercial real estate had just such a stimulating measure behind it.
IITs a tonic for the economy
State-of-the-art, well-maintained infrastructure is essential for countries to keep their competitive edge. Telecommunications infrastructure is ever more important to business and in our private lives, and this sector will form the spine of the transition from 4G to 5G.
While the US leads the world in innovation, business sophistication, financial markets and higher education, it lags in the basic economic structural pillars, of which transportation infrastructure is one.
The challenges of funding and operating infrastructure in today’s economy require an enlightened approach to attract private capital through the widest possible global investor base. A listed infrastructure vehicle, through a de novo, clearly defined IIT, could provide global investors with a familiar, easily understandable and liquid exposure to infrastructure and inject economies with fresh, essential capital.
The moment is right for governments to join forces with the private sector to build out the proposals found in the G20/OECD Report.
Ben Morton is head of global infrastructure and a senior portfolio manager at Cohen & Steers, and Fraser Hughes is founder and CEO of GLIO
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