By Simon Burgess, Head of Alternative Investments | OCORIAN
Infrastructure investing is rapidly maturing. As institutional investors seek risk adjusted returns from their physical and real assets, Head of Alternative Investments, Simon Burgess highlights how infrastructure gives access to longer term income with enhanced capital security, with similarities to that experienced in real estate investing.
Effective infrastructure is a vital foundation to economic development that supports sustainable, long-term growth. As time and technology have progressed, the umbrella of infrastructure has broadened to encompass many different combinations. From businesses and buildings, roads and rail, to water systems and data centres; infrastructure is a pillar of modern society giving those who benefit a higher quality of life.
Flagging government commitment, rising investor demand, technological innovation, greater customer expectation and an evolving regulatory landscape are all contributing to an increase in the appeal of infrastructure to private investors. Spanning the risk-return spectrum from lower risk public-private partnerships (PPP) in developed economies, up to more private equity-like (and therefore higher risk) assets in less developed countries, infrastructure investing can play a valuable role in portfolio strategies. Research conducted with 200 intermediaries by independent infrastructure and private equity investment manager, Foresight Group LLP revealed that 62 per cent of financial advisers are looking to increase their clients’ allocation to infrastructure over the next three years, a dramatic increase from 32 per cent in 2018.
Infrastructure investing also shares a number of similarities with that of real estate investing, including its investment appeal. They are now becoming part of the same conversations as traditional real estate investors seek longer term returns.
A real plateau?
In the UK, with Brexit impacting the economy, the real estate investment market has been exposed to specific investment strategies targeted by non-UK investors. Immediately following the Brexit vote, there was an influx of foreign capital from Asia, the Middle East particularly, but also North America. They clearly took the opportunity to capitalise on the negative hit that Sterling took following the referendum vote.
In isolation, such currency play strategies are not necessarily a major issue, but they do open the door for the types of investment plays favoured by, say, Korean investors. While relative capital values fall (driven by weaker currency), Korean investors have capitalised on short-term currency boosts to obtain returns on their capital investments of 3% to 4%; compared with 1% to 1.5% which is commonplace in their home jurisdiction.
In conjunction with Brexit, foreign investment strategies have certainly played their part in the levels of confidence in UK real assets as a whole. A 2017 survey by the British Property Federation (BPF) and Grosvenor Britain & Ireland revealed that confidence surrounding the real estate sector’s performance over the following year dropped from 88% to 40%.
For UK institutional investors, such foreign strategies have created a fully priced home market pushing yields down and values up. This has made capital deployment a tough job for UK based real asset investors. Non-UK investors have benefitted, but as the market settles into a new norm, there will be a renewed focus on stable long-term returns; an attractive aspect of infrastructure investment.
Hitting the mainstream
Previously occupied by major pension and sovereign wealth funds seeking liability matching yields and inflation protection, infrastructure projects are often income-producing real asset-backed investments that frequently offer attractive returns over the long-term. In many cases, infrastructure investments are dependable, unique assets offering portfolio diversification and can transcend political and economic cycles. It is also seen as necessary. McKinsey Global Institute estimates that USD$3.3 trillion must be spent annually through to 2030 in order to support expected global rates of growth.
In conjunction with the stresses and strains of real asset investing in its widest sense, infrastructure is feeling the benefit of an increase in the number of funds with substantial ‘war chests’ of capital to deploy. It is important to note that this does not mean that more capital is being deployed across the market, just that the capital being collected is being deployed through larger funds; albeit across a fewer number of funds.
For example, over the past five years DWS, one of the world’s top fiduciary infrastructure fund managers, successfully closed two Pan-European Infrastructure Funds (“PEIFs”) raising €4.7 billion in total commitments by focussing on core unlisted European infrastructure investments. Similarly, Brookfield Asset Management and Global Infrastructure Partners have closed a number of flagship infrastructure funds, with the latest expected to top a cool USD$14bn.
In the UK, despite Brexit uncertainty it remains an attractive destination for foreign capital seeking medium to longer term investment prospects. The 2019 edition of The Global Infrastructure Hub and EDHEC Infrastructure Institute (EDHECinfra) survey ranked the UK as the third market with the most potential for private infrastructure investment over the next five years.
There are a number of interesting UK projects potentially on the horizon. Prime Minister Johnson may push through the introduction of a new 5G network, and he’s indicated extra expenditure for hospitals. Extensions to the rail network, especially the High Speed project, are also obvious candidates. Also, recent talk of “Free Ports” throughout the UK after Brexit will demand additional infrastructure and real estate development.
A familiar alternative
Infrastructure investments often exhibit similar characteristics to both real estate and private equity investments, making them a relatable and attractive alternative.
A good example of an asset-backed infrastructure investment (sharing both real estate and private equity characteristics) is that of ports. Ports have both operational and logistical aspects that make them very similar to private equity investment plays. Also, given the underlying real estate interests, such infrastructure investments are subject to economic fundamentals and real estate market forces specifically where part of the asset’s capital value is derived from leasing activities, rental growth and property risks implied in valuation yields.
Ticket sizes can also be cited as a shared characteristic between private equity and infrastructure investments. The individual ticket sizes of larger funds are greater, with the pool of potential investors being smaller due to the higher capital demands of bigger investments. As a result, this causes a thinner investment market, a characteristic more prevalent within a private equity structure.
In addition to the common advantages of infrastructure investments, the table below compares the similarities that infrastructure has with both private equity and real estate investments, adding colour as to why infrastructure is a popular alternative:
|Private Equity Similarities||Real Estate Similarities||Advantages|
|Infrastructure||• Larger capital value
• Larger ticket size and similar fund characteristics
• Operational and logistical aspects to consider and run
• EBITDA based valuations
|• Real Estate based
• Dictated by traditional RE market forces
• Continuous revenue stream through rents
• All risk yield based capital valuations
|• Long duration, enduring dependable asset
• Continuous revenue stream through rental income streams
• Provides diversification
• Variable valuations bases (depending on specific asset type)
The rise of the non-traditional REIT
Infrastructure investing has also featured within the Real Estate Investment Trusts (REITs) market. REITs are now an integral pillar of the global property market. They offer an attractive exit route for a privately built portfolio and they are investor friendly, tax efficient vehicles for real estate investment. There are 50 listed on the London Stock Exchange alone. In June 2017, REITs occupied a total market cap of approximately $1.3 trillion globally, representing 41% of the listed real estate industry worldwide.
Traditional REIT investment opportunities include retail, office, residential and industrial sectors. There are dedicated infrastructure REITs which own and manage infrastructure real assets with rental income stream characteristics. Infrastructure property types may include data centres, ports, airports, wind and solar farms, fibre cables, timber, wireless infrastructure, telecoms towers and energy pipelines; all expanding markets in their own right.
We can expect the next wave of innovation to come from the ability to list individual property investments and infrastructure assets. IPSX, launched this year, is the first regulated securities exchange dedicated to the initial public offering and secondary market trading of companies owning single institutional grade real estate assets and multiple assets with commonality. And, the EIX (Estates and Infrastructure Exchange) was established to focus on the $2 trillion annual gap of unfunded global infrastructure projects they have identified.
A world in need
With the global population increasing, the demand for infrastructure has never been greater. As McKinsey highlight, from 2016 through to 2030 the world needs to invest $3.3 trillion per year (3.8% of global GDP) just to ‘support expected rates of growth’. If the current trajectory of under investment continues, this target will be missed by $350 billion per year. These figures highlight a necessary and permanent demand for infrastructure investment, which present a huge opportunity for private capital to fill the gap.
Ocorian’s infrastructure fund administrators can help you establish fund structures in addition to providing ongoing fund administration and other accounting services. Learn more here.
Compliments of Ocorian, a member of the EACCNY