Listed Infrastructure: IIT solutions
Does infrastructure need its equivalent of a REIT? Fraser Hughes and Ted Brooks make the case for the IIT
A common objection to private involvement in infrastructure investment is a political concern that Wall Street and large private equity firms would unfairly benefit from owning assets that populations need to use. However, there is a way to protect against this and to offer the opportunity for the wide ownership of infrastructure. In fact, this idea has already been tried and tested for decades.
The real estate investment trust (REIT) model, which existed for over half a century in the US and has spread to all other major economies in the past 15 years, has allowed tens of millions of individual investors either directly, or through their retirement savings, to enjoy the benefit of investment in commercial real estate. Today, for example, about 25% of all US commercial real estate is in the hands of such investors through the $1trn (€876.4bn) REIT market.
Another example is the master limited partnership (MLP) model, which has been successful in stimulating broad ownership of US energy pipeline infrastructure.
We believe that access to infrastructure investments for a broad range of investors can be achieved by creating a similar vehicle that democratises ownership via the equity market. A listed structure able to efficiently invest in infrastructure assets would enhance the available pool of capital for mission-critical infrastructure investment.
Structuring a listed infrastructure investment vehicle could follow two paths – either through a purpose-built infrastructure investment trust (IIT), or through the expansion of existing REIT/MLP structures.
While there is broad agreement on the need for significant investment in global infrastructure, the question of how to pay for it is more contentious, with different views of how to attract essential private capital to finance public assets. The US, for example, has a long history of successful private-market solutions to infrastructure needs, dating back to the creation of the US railway system over 150 years ago.
More recently, listed investment structures such as REITs and MLPs, targeting telecommunication infrastructure and energy pipelines respectively, have proven successful in answering the challenge of stimulating private investment to address infrastructure needs by offering access to the widest possible pool of capital. In fact, more than 35 countries around the world have adopted the US REIT structure.
We believe that tapping into private capital to fund broader public infrastructure investment presents a mutually beneficial opportunity to meet a public need and broaden the investable infrastructure investment options to generate stable, compelling returns for investors.
In addition, by making the investment opportunity available broadly – via a listed structure – it would democratise participation in the ownership of a nation’s infrastructure. For example, it is estimated that 80m Americans own REITs through retirement savings and other investment funds. That is a true success story. We believe an IIT can do the same for infrastructure, paving a way to efficiently finance infrastructure investment.
Structuring a listed infrastructure investment vehicle has a few options. All have the potential to be included in future infrastructure-related legislation at no cost to the taxpayer, as outlined below.
The success of REITs and MLPs, which have led to more than $1trn of new investment, including infrastructure-related projects like pipelines and telecom infrastructure, could be leveraged by expanding the scope of these vehicles to encompass a broader range of essential infrastructure. To implement this, there are primarily two issues to address: the current definition of ‘qualifying assets’ (the type of assets that can be owned); and ‘qualifying income’ (the need to structure income streams as rent payments) for REITs and MLPs.
Solving the criteria for qualifying assets may be reasonably straightforward. The REIT and MLP models already allow for the ownership of ‘real property’, which includes land and structure, and hence allows infrastructure ownership. However, the definition of qualifying income is more complex.
“Access to infrastructure investments for every investor can be achieved by creating a listed vehicle that democratises ownership via the equity market”
The REIT structure requires qualifying income to be in the form of a rent payment, and MLPs require either a rent payment or commodity-related income. This would challenge the efficiency of owning infrastructure assets through REITs or MLPs, given the broader scope of infrastructure, the conventional pricing models for infrastructure assets, and the current interpretation of rent by regulators. Infrastructure involves more than simply commodity infrastructure, and pricing for the use of these assets is often articulated as a toll or a fee, which traditionally has not been viewed as a rent payment – although a loosening of the definition to include tolls and fees could help in this situation.
Alternatively, a new purpose-built, IIT could leverage much of the success of REITs and provide a clearly defined path for attracting infrastructure investment. An IIT structure could be designed to be specifically tailored to the characteristics of infrastructure assets, including the nature of qualifying assets and qualifying income.
Specifically, an IIT would define qualifying income to include revenues derived from the transmission, transportation, and/or distribution of energy, power, data, and vehicles (air, sea, road, rail).
This definition would cover the ownership of electric, gas, and water utilities, telecommunication/data, physical architecture, and both freight and passenger railways, airports, seaports, bridges, and toll roads.
Much of global infrastructure investment requires new construction projects. This involves a period of no income and, in fact, losses from upfront investment. An IIT would need to capture the tax-loss pass-through benefits of a private partnership structure, which cannot be captured in current REIT rules. An IIT that includes the ability to pass through tax losses to offset an investor’s ordinary income would create a powerful investment incentive from a broad base of long-term global investors. The effect of such a measure could be significant in stimulating new construction.
New and upgraded infrastructure is essential for the global economy. Funding and operating infrastructure in today’s economy require an enlightened approach to attracting private capital through the widest possible global investor base. A listed infrastructure investment vehicle, either through an IIT, or through the extension of the current REIT/MLP structure, can provide investors with a familiar, understandable, and liquid exposure to infrastructure.
As the global infrastructure asset class develops, it is paramount that governments create the conditions for the efficient deployment of capital to maintain and upgrade national infrastructure. In addition, governments need to proactively encourage the development of new infrastructure projects that offer long-term economic benefits and that are constructed under the eye of an environmentally aware global investment community. We believe the estimated $150bn of ‘dry powder’ currently searching for infrastructure exposure is only the beginning.
Perhaps the climate is right for the US to take the lead and create an IIT, as it created REITs over 50 years ago. The US has the opportunity to satisfy long-term investor demands for attractive-yielding stable income, plus offer shareholder and regulatory transparency. Moreover, an IIT will contribute in the long-term upgrade and development of critical US infrastructure, without increasing the tax burden on the US population.
Fraser Hughes is CEO of GLIO, and Ted Brooks is portfolio manager, global listed infrastructure at CenterSquare Asset Management