Deloitte: REITs the New Infrastructure Investment Opportunity

April 19, 2010
By Allison Landa, News Editor and Barbra Murray, Contributing Editor

Courtesy Flickr Creative Commons user Orin Zebest

According to a new report from Deloitte, REITs could offer a potential avenue for infrastructure investment.

“Coming out of the economic downturn, private investors are seeking new avenues to generate tax-efficient returns on their invested funds,” reads the report, titled “REITs and Infrastructure Projects: The Next Investment Frontier” It continues on to say that the infrastructure sector continues to attract private investor interest, particularly as more governments look to public-private partnerships to provide funding.

From highways and public transportation to waste disposal and water supply to energy and modes of communication, U.S. infrastructure is in sore need of repair, as well as expansion to accommodate the country’s mushrooming population. While the federal government has allotted $35 billion through the American Recovery and Reinvestment Act of 2009 for highway and public transportation improvements alone, as Deloitte notes in the report, the American Society of Civil Engineers’ 2009 Report Card for American Infrastructure estimates that $2.2 trillion is needed to sufficiently upgrade the system. REITs, according to Deloitte, could pick up the financial slack for these projects. It’s all about private capital and public-private partnerships.

“In recent years, private investors have expressed interest in adding infrastructure assets to their investment portfolios,” it asserts. “In general, private investments are often made via flow-through investment vehicles, such as limited liability corporations. However, recent Internal Revenue Service private letter rulings may now allow investors to use REITs as an alternative investment structure.”

According to Deloitte, the topic of private investments in infrastructure has grown amongst politicians and financial professionals, with the use of a public-private partnership structure in use in countries including Australia, Canada, France, and the United Kingdom. Through these partnerships, the public sector grants a private-sector party or consortium a long-term concession for responsibility for some or all of the design, construction, financing, operations and maintenance of a publicly owned asset. In the U.S., however, these partnerships are relatively new and at some points have created controversy.

That said, Deloitte notes that several high-profile transactions in the U.S. have reported significant financial benefits.

“These successes, combined with a growing need to spend trillions of dollars repairing and constructing roads and bridges, airports, and electric, gas and water distribution systems, as well as hospitals, courthouses, and prisons,” the report reads, “are causing supporters to believe that increased access to (public-private partnerships) would be a welcome complement to traditional infrastructure financing using tax-exempt bonds.”

The report lists several advantages of REIT investments in infrastructure transactions: liquidity, incremental scalability, capital market access, and taxation.

“In short, REITs offer certain advantages over partnerships in their ability to raise capital from diverse sources, particularly foreign investors,” the report notes. “In addition, expanding the investor base to individual investors may increase the availability of equity capital for infrastructure projects.”

While there are pluses to the infrastructure REIT concept for public-private projects, there are also a few drawbacks. The majority of public-private partnership endeavors will produce sizeable tax losses in the initial 10 to 15 years of operation, losses that would not pass through to REIT shareholders. Additionally, relying on a REIT as an investment vehicle for infrastructure projects would also present income test barriers. However, Deloitte points to a couple of feasible solutions to that obstacle.

One option would be new legislation creating Infrastructure Investment Trusts that would allow for the classification of revenues from public-private partnership infrastructure participation–including rent from real property–as qualifying income, thereby eliminating the test barriers. Another solution would be the incorporation of a new system that would permit infrastructure assets to be owned or leased by a Taxable REIT Subsidiary without the existing restrictions on the total value of the REIT.