Local governments are desperate to fund bridges, pipelines and toll roads at a moment when muni bonds no longer satisfy the wealthiest families’ low-risk cash flow needs. Is infrastructure the next must-have alternative asset class?
[caption id="attachment_10067" align="alignright" width="293"] The Garcon Point Bridge has been a nightmare for bond holders -- but maybe a dream for private equity?[/caption]
Call it the perfect storm or the next trillion-dollar place where money can get to work, matching investors to infrastructure is looking like the theme of the decade.
The drive to build whole cities in places like China and India have been creating fortunes and headlines for years while American dams, roads and power plants have only needed the occasional patch or other renovation work.
Unfortunately, U.S. infrastructure that predates the Baby Boom is reaching the end of its usable life at exactly the wrong time for Washington to scrape up the will or the capital to get the bulldozers moving.
A previous generation might have filled the gap by selling municipal bonds, but now some of the hottest family office investment officers around are urging their clients to demand a richer piece of the action.
“Traditional public sector projects such as bridges, highways and hospitals are increasingly being supplemented by new private/public partnerships,” the elite Wigmore Association recently proclaimed on behalf of associated family offices.
And at least one has jumped at the opportunity.
“We will be prioritizing research on global infrastructure investing for wealthy families,” Rick Pitcairn of the Pennsylvania-based Pitcairn Group tells his clients.
The race to rebuild America and own the assets at the end of the day is underway. Strap in.
Anatomy of a hot asset class
The biggest macro driver here is easy enough to understand: one way or another, the roads must roll if the economy is going to survive, much less prosper.
From interstate highways to elementary classrooms, a lot of the core development in this country was funded in the 1950s and early 1960s.
Parts of the water works and the power grid -- the classical Monopoly-era “utilities” – are even older and showing more obvious signs of wear.
Add in ports, dams and other massive projects and the number crunchers at the American Society of Civil Engineers estimate that it’s going to cost $2.7 trillion between now and 2020 just to keep everything up to code.
There’s just not enough money for that in Washington’s wallet as expiring stimulus budgets and new austerity programs slam the spending spigot shut.
And with states and county governments back on default watch, the ASCE estimates that if private investors don’t come up with $1.1 trillion of that cash on their own, the wheels start coming off.
In other words, those private investors can write their own ticket for participation – and earn a lot more than the 3% to 4% they might squeeze out of the muni market.
The key to generating double to triple those returns is direct equity, whether it’s structured as a limited liability company, REIT or a more complex public/private partnership.
So far, the big infrastructure REITs have taken their cues from the master limited partnership industry and focused on energy: fuel pipelines, power plants, the electrical grid itself.
That leaves the biggest and most dilapidated sectors – surface transport and water, respectively – for LLCs to divide and conquer.
The good news is that owning a toll road through an LLC or other pass-through vehicle can produce more impressive current post-tax income than just about any muni bond portfolio, and that’s nothing to sneeze at in a world where Treasury yields are still orbiting record lows.
But the LLC structure can start to look like an investment pool very quickly, which defeats the purpose of direct ownership. If your clients wanted another exotic mutual or hedge fund, you’d get that for them.
Direct investment may require more hands-on management but it provides high-net-worth families with transparency, a concrete sense of ownership and a chance to exercise their entrepreneurial talents.
With a more closely restricted direct holding, the owners can fine-tune the business to suit their cash flow needs, rather than having to find an existing operation that fits requirements or worse, fine-tune their requirements to the opportunities out there.
Back to the REITs
Of course, it also means finding the right raw project to back in the first place.
Plenty of recently constructed toll roads, for example, are so insanely leveraged that they’ll never pay off their backers unless active management leads an aggressive turnaround.
Take the sad case of the Garcon Point toll road in Florida, which raised $116 million in debt to build, keeps limping along at about $400,000 in revenue a month and has been technically in default on its bond payments since mid-2011.
Critics say the road’s managers should swallow their pride and drop the toll to lure more cars across. But others say there just isn’t enough traffic in the region to ever pay back the investors at any price.
Either way, Garcon Point has been a miserable experience for bond holders but might make a great fixer-upper for the right wealthy family eager to take on a project and buy the concession.
While utility stations and gas pipelines have a rosier outlook, the expertise required to be anything but a silent partner is probably too specialized for most of your clients to even contemplate.
Accountants at Deloitte would prefer to see your clients get their exposure in these sectors via REITs now that the IRS has ruled that a real estate investment trust can indeed own electrical and gas distribution assets.
The theory here is simple enough, but once again, you’re bumping up on the direct versus indirect issue, and it’s unlikely in any event that a REIT will be able to claim that tolls and access fees are passive rent anyway.
Furthermore, Deloitte points out that most public/private infrastructure partnerships generate “significant” tax losses for 10 to 15 years even after they’ve been built out and opened for business -- it simply takes that long to start operating in the black.
That’s a long time for a family looking for current income today to sink their capital, even assuming that they can break ground and build something new in the ultra-near term.
For those who can’t wait, there are lots of aging facilities looking for fresh investment and new active management willing to pick up the concession and reap the rewards: toll roads, ports and airports, hospitals, even prisons.
“The nature of these investment assets – long term, low risk and usually carrying significant dividend components – are very attractive to high-net-worth families,” the gurus at the Wigmore Association say.
Maybe that bridge in Florida doesn’t look so bad after all, if you can get that $400,000 a month in current income at the right price.