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Street Smarts

Infrastructure Emerges as New Asset Class

With so much capital flowing into traditional real estate sectors like office and retail, many investors are looking for better returns in a new asset class - infrastructure.

"The low hanging fruit for real estate has been picked, and infrastructure seems to be ripe for investors looking for stable cash flow and value appreciation," says David Rosenberg, a partner in Cox Castle & Nicholson LLP's Los Angeles office. He recently helped an institutional client invest $100 million in an infrastructure fund as part of its real estate strategy. "It's a great alternative investment," he contends.

Building, repairing, operating and owning water, electricity, and transportation systems around the world can be very profitable, according to Booz Allen Hamilton. The global consulting firm estimates five-year returns for infrastructure assets range from 11 to 13 percent for airports, 10 to 13 percent for toll roads, 8 to 10 percent for rail and 10 to 14 percent for wastewater plants.

Infrastructure assets are very similar to commercial real estate assets, says Bob Preito, senior vice president of Fluor Corp., a construction and engineering firm that is involved in a $1 billion toll road project in metro Washington D.C. The Dallas-based company partnered with Australia-based Transurban to add four lanes to Interstate 495 and holds a 10 percent equity stake in the project. Similar projects achieve internal rates of return near 12.5 percent.

"When investing in infrastructure, your return is tied to how much you can increase the revenues while controlling expenses related to ongoing maintenance," Preito notes. "It's just like buying a building and increasing rents."

Embracing privatization

Ernst & Young predicts the infrastructure investing market will quickly rival other real estate-related investment markets such as CMBS, REITs, and private equity in terms of market size. "The private sector is going to play an expanded role in the coming global movement to build and modernize the world's infrastructure," says Dale Reiss, director of Ernst & Young's Global Real Estate Group.

There is a huge need for infrastructure across the globe. Over the next 25 years, modernizing and expanding the global water, electricity, and transportation systems will require approximately $40 trillion - an amount roughly equivalent to the 2006 market capitalization of all shares held in all stock markets in the world, according to Booz Allen Hamilton.

From railroads and mass transit to telecommunications and power and water systems, there is a dire need for infrastructure in developing countries. But, that's not to say that the need for infrastructure repairs in developed countries isn't acute. The U.S., in particular, will under spend on needed infrastructure investment by approximately $1.6 trillion dollars over the next five years, according to the Army Corp of Engineers.

"Governments around the world are realizing they have to make major investments in their infrastructure, but they don't have a way to fund and finance it," says Chris Lawton, a partner with Ernst & Young. "Developed countries need to upgrade and developing countries have to build from scratch."

Infrastructure projects have never been cheap, and they're getting more expensive as developing countries like India and China ravenously consume raw materials and labor in their quest to join the 21st Century. For example, modernizing the 52-year-old Tappan Zee Bridge, which connects Connecticut, New Jersey and New York City, could cost anywhere from $3 billion to $15 billion.

In the past, these hefty infrastructure projects have been financed in a variety of ways including: income, sales, and property taxes and user fees such as tolls, subway fares, and water bills. But, these revenue sources just aren't adequate to fund all of the new infrastructure projects that are needed. Even worse, money for basic infrastructure repairs is running out: the Federal Highway Trust Fund, which provides the monies to maintain and construct interstates, will be bankrupt by 2009.

Although traditional methods of financing infrastructure are still important, the private sector is emerging as a solution to fund new projects and to repair antiquated assets. Through public-private partnerships, or PPPs, pension funds, insurance companies, equity funds, high-net worth individuals and investment banks are joining with public agencies to build, manage and operate infrastructure assets such as toll roads, bridges and tunnels.

Funds target U.S.

Although privatization of infrastructure isn't a new concept, it's just now gaining traction in the U.S. "When it comes to public-private partnerships, the U.S. is still a developing country," Preito says.

In Europe, PPPs have been building and operating toll roads since the 1970s. More recently, airports and ports have been privatized, as have school and hospital management. During the mid-1990s, Australian investment firms established the first infrastructure funds in the world. For example, in 1996, Macquarie Bank launched Macquarie Infrastructure Group (MIG), which trades on the Australian Stock Exchange. MIG invests in tollroads and boasts an average return of 19 percent.

The rise of private infrastructure investing in Australia coincided with reduced government spending (from 7.2 percent of GDP in 1970 to about 3.6 percent in 2006), according to Booz Allen Hamilton. Today, more than $30 billion of Australian infrastructure assets are held in publicly traded or listed entities.

In addition to Europe and Australia, PPPs have been embraced in Canada, India, Asia, and South America. And, over the past 12 months, several investment funds have been established including: Goldman Sachs's $3 billion global fund; Macquarie's $964 million infrastructure fund in South Korea; and the Infrastructure Development Finance Corp.'s $350 to $450 million fund in India.

However, most industry experts contend that the U.S. offers the best infrastructure investment opportunities now that 28 states have passed legislation enabling private market investment in infrastructure. Moreover, the U.S.'s legal transparency and political stability makes it more stable than developing countries that must deal with the risk of war, famine, political unrest and corruption.

MIG was one of the first investors to focus on U.S. infrastructure. In early 2006, the Australian firm partnered with Spanish investor Cintra to acquire a 99-year lease of the Chicago Skyway, a six-mile stretch connecting Indiana and Illinois, for $1.83 billion. A few months later, the duo paid $3.85 billion to gain control of Indiana's 153-mile East-West Toll Road for 75 years.

Since then, several large investment firms have followed the MIG's lead with plans to invest in multiple infrastructure projects. For example, New York-based Carlyle Group is raising a $1 billion fund to focus rail, airports, water assets, schools and hospitals. Similarly, Alinda Capital Partners LLC, also based in New York, is raising a $1 billion infrastructure fund to invest in the U.S.

Rosenberg's institutional client chose Alinda's fund for its first infrastructure investment after mulling over infrastructure opportunities for quite a while. "My client likes to plow money back into the communities they represent," he explains. "Infrastructure provides great returns for investors while also allowing them to participate in a social service for the community by providing better roads or waste treatment. As an investment, it really fires on all cylinders."

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