Driving infrastructure investment

As infrastructure evolves, private equity is turning to the sector in search for higher yields. Theo Andrew investigates the opportunities it represents for investors

Infrastructure has proven itself as a major asset class over the past few years, and according to Preqin’s latest data, private equity funds have exceeded targets for the year to date, hitting 107 percent, but as investors turn their attention towards infrastructure, the way it is defined is changing.

Traditionally pegged as roads, bridges and airports, the sector has been a playground for pension funds searching for the longevity of a stable yield, but technological advancements, an ageing population and a squeeze on traditional asset classes are changing the dynamics of the sector.

Institutional investors, both private and public, are broadening they way they look at infrastructure and are focusing on much more than the nuts and bolts, according to Bevis Metcalfe, special situations counsel at Ropes & Gray.

“A lot of investors are interested in the infrastructure space, but they are not comfortable with taking developmental and operational risk. They can live with one or the other but the combination of both is probably too much,” says Metcalfe.

Although there has been a rise in private equity entering infrastructure, pension funds still dominate the space.

In July, Deutsche Asset Management (AM) successfully raised €1.8 billion for its Pan European Infrastructure II fund, of which pension funds and insurance companies raised 80 percent. The fund hit €2.5 billion after a further €800 million commitment from Deutsche AM.

There has been a notable strategic swing towards the asset class from private investors, as they find themselves squeezed out of traditional real estate classes in search of long-term stable yields.

Naman Pathak, managing director at Pathak Properties, said: “For private investors, this provides an opportunity to invest into a secure asset class with reasonable returns. Further to this, there is a huge array of projects one could invest in, from nuclear plants to airports to digital, meaning that investors can contribute to a specific area of interest whilst also receiving a return.”

On top of the stability of investing in infrastructure, the awareness that it brings to the investor and the boost it gives to the country are key, says Pathak.

“Those that invest or consider investing into infrastructure projects take a keen interest in the country’s spending, which in time will help the government to prioritise its spending on such projects accordingly. This can only be a good thing for our economy, that too without layering the country with more debt.”.

Technological advancements

A disruptor for some, technology’s place in the real estate world has no doubt provided opportunities for investors savvy enough to take advantage in areas that would be hard to comprehend a decade ago.

“A sub-sector which our clients have found particularly exciting are businesses with infrastructure characteristics, card payment process service providers for instance,” Metcalfe says.

A good example of this is Worldpay. Listed on the FTSE 100, the payment processing company touches on the everyday needs of society without messiness and illiquidity of large scale real estate.

Metcalfe adds: “Everybody needs them, but they are not regulated in the way that traditional infrastructure is, meaning they see a lot of upside, and uncapped upside because they are not subject to regulation in the same way as traditional infrastructure.”

It is the infrastructure-like characteristics of these new technologies that are driving interest in the sector. Perhaps the most tangible example of this from a real estate point of view is the humble
data centre.

The emergence of the cloud and data-based products mean the asset class is on a journey to becoming a mainstream option, particularly for REITs.

In June, Digital Realty Trust, which connects approximately 2,300 firms across its global portfolio of networks, announced its intention to acquire DuPont Fabros, a transaction that would be valued at approximately $7.6 billion and increase the company’s presence in US data centre powerhouses Northern Virginia, Chicago and Silicon Valley.

Digital Realty itself reported Q2 2017 revenues of $566 million, a 3 percent increase from the previous quarter and a 10 percent increase on Q2 2016. These results pale in comparison to the industry’s returns as a whole.

Data centres achieved returns of 22 percent in the first half of 2017, while total returns from infrastructure REITs also reached 22 percent over the same period, according to the National Association of Real Estate Investment Trusts.

For those ready to grapple with technological innovation, real estate has proven to be a real growth area, but changes in other corners of society have investors approach infrastructure in a unique way.

Social infrastructure

The housing crisis in the UK and the realisation of many millennials that they may never be able to buy their own property mean that the private rented sector (PRS), also known as build to rent (BTR), is an area that investors have been watching closely, attracted by the long-term cash flow that it promises.

Carol Hopper, real estate partner at Ropes & Gray, explains: “Infrastructure has been hitting the headlines but it is interesting to note how often recently clients have spoken about infrastructure, as a sector of interest, in a very broad sense. Particularly in the context of ‘social infrastructure’, meaning investment in the social fabric of our society, including PRS, and student and senior living accommodation, but also healthcare.”

PRS in particular has been able to build much of the resilience of a traditional infrastructure investment, offering a strong and stable return profile, robust through cycles, and less volatility risk, as well as a genuine answer to a national problem.

She adds: “These investments have many aspects in common with more traditional infrastructure transactions, not least the need to understand development risk and income and operating expenses. Their long term nature make them particularly attractive to a number of investors.”

While pension funds might still be the main source of funding for many infrastructure projects, the ears of many private equity holders may have pricked up.

As innovation continues to shape the way we live, real estate investors willing to seize an opportunity have a chance to shape, and house, society.
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