While there is broad agreement on the need for significant investment in U.S. infrastructure, the question of how to pay for it is more contentious, with different views of how to privately finance public assets.

The United States in fact has a long history of successful private market solutions to infrastructure needs, dating back to the creation of our railway system more than 150 years ago. More recently, listed structures such as REITs and MLPs, targeting telecommunications and energy pipelines, have proven successful in answering the challenge of stimulating private investment to address infrastructure needs by offering access to the widest possible pool of capital.

Tapping into private capital to fund broader public infrastructure investment presents a mutually beneficial opportunity to meet a public need and generate compelling returns for investors. In addition, by making the investment opportunity available broadly via a listed structure, it would democratize participation in the ownership of our nation’s infrastructure. We believe that a listed structure, either through a purpose-built Infrastructure Investment Trust or by expanding the scope of REITs or MLPs to more efficiently allow infrastructure investment, would act as a magnet for capital to fund new infrastructure development, reduce pressure on government balance sheets, and allow the broadest possible infrastructure ownership. What is needed to unlock this potential wave of new investment, and the associated increase in jobs and economic activity that would follow, is a 21st century reimagining of some of the 20th century’s most successful corporate structures and concepts.

DECADES OF UNDER-INVESTMENT

The United States ranks 25th in the world for the overall quality of infrastructure. The last time the United States had a comprehensive infrastructure investment plan was two generations ago, and many of the assets built then were only intended to last 50 years. Since that time, our infrastructure needs have also evolved. Today, the definition of infrastructure has broadened to include information technology, renewable energy and improved urban transportation. Further, modernizing our infrastructure requires a significant investment in technology — such as variable lane highway pricing models and GPS-based air traffic control systems — an area where the private sector has traditionally been more adept than the public sector.

MEETING THE CHALLENGE WITH PRIVATE CAPITAL

Private capital brings a number of advantages to meet the challenge for new infrastructure investment. When private capital acquires the right to build and operate infrastructure through a government-granted concession, the initial investment is subject to an economic viability test through the underwriting and bidding process, helping ensure that infrastructure spending is focused on economically necessary projects. Further, a profit motive encourages operational efficiency and the conditions of the government granted concession make the private owner/operator accountable to the public for high-quality outcomes. Such “public private partnership” models have historically been used successfully to meet many of the infrastructure challenges that have faced our nation, including the construction of much of our national railway. A common argument against private investment in infrastructure, that it will increase costs, misses the fact that our infrastructure is already not free. We currently pay for public infrastructure through our taxes. However, because the performance of publicly built and operated infrastructure assets is not subject to market forces, these operations have the tendency to suffer from wasteful spending and inefficiency. As an alternative to private construction of new infrastructure, allowing broader private ownership of infrastructure assets should create a deep pool of competitively priced private capital to purchase existing assets, freeing up capital to be redeployed by the government into new projects. Capital from infrastructure asset sales could be ring fenced for new infrastructure investment, which in turn could be sold into the private sector once stabilized. Such an asset recycling model could create a self-
regenerating source of capital for infrastructure development.

DEMOCRATIZING INFRASTRUCTURE INVESTMENT

Another common objection to private involvement in infrastructure investment is a political concern that “Wall Street” and large private equity firms would unfairly benefit from owning assets that we all need to use. But there is a way to both protect against this and broaden the opportunity for ownership of our nation’s infrastructure. Access to infrastructure investments for every investor can be achieved by creating a vehicle that democratizes ownership via the equity market. This idea has already been tried and tested — the real estate investment trust (REIT) model in the United States has allowed tens of millions of individual investors either directly or through their retirement savings to enjoy the benefit of investment in commercial real estate. Today, about 25 percent of all U.S. commercial real estate is in the hands of such investors through the REIT market. Another example is the master limited partnership (MLP) model, which has proven to be successful in stimulating broad ownership of our energy pipeline infrastructure. A listed structure able to effectively invest in infrastructure assets would maximize the available pool of capital for infrastructure investment and the price the public can achieve for the value of these assets.

One available option to create a listed entry into the infrastructure investment opportunity would be to expand the scope of the existing REIT or MLP structures to efficiently allow investment in infrastructure assets. An alternative option is to create a purpose-built vehicle — an infrastructure investment trust — building on successful aspects of the REIT and MLP models, but specifically focused on infrastructure investment.

Creating an appropriate listed structure to allow infrastructure investment could open the floodgates of private capital into our under-invested roads, rails, airports, power grids and energy infrastructure, and also democratize infrastructure ownership. The steady cash flow characteristics of infrastructure projects would also mean that such a vehicle could be used as part of a stable, lower volatility, yield-oriented investment allocation, which will be in increasingly high demand by investors in an aging population.

INCREASING THE TAX BASE

If enacted, the introduction of an infrastructure investment trust either through a de novo structure or the expansion of current REIT/MLP structures should act to increase the tax base. Currently, publicly owned infrastructure competes with private business (i.e., private airlines vs. government-owned rail) but is not part of the tax pool.

If owned privately, these assets would then contribute to the tax base. For example, in the case of an airport, states and municipalities would benefit from an increase in property taxes, and dividend payments and capital gains would also be taxable. For those infrastructure assets that are already privately owned, there would be very little change in the effective rate paid by most corporate structures and any dividends paid would remain part of the income tax base. For instance, the midstream energy space already avoids double taxation through the MLP structure; the utility industry in the United States — through a combination of accelerated/bonus depreciation, renewable tax credits, and NOLs from existing business lines — is already a negligible cash taxpayer relative to statutory rates; cell towers are largely concentrated in the hands of businesses already structured as REITs; and airports, seaports, bridges and toll roads are almost entirely held by state and municipal entities, placing them outside of the tax base for most calculations. As a result, we believe the creation of an infrastructure investment vehicle would lead to a net add to the existing tax base.

Structuring a listed infrastructure investment vehicle could follow two paths, which have the potential to be included in upcoming infrastructure-related legislation at no cost to the taxpayer, as we outline below.

Expand the scope of the REIT or MLP structures: The success of REITs and MLPs, which have led to more than $1 trillion of new investment, could be leveraged by expanding the scope of these vehicles to encompass infrastructure. There are primarily two issues to address to implement this approach — the current definition of REIT and MLP “qualifying assets” (the type of assets that can be owned) and “qualifying income” (the need to structure income streams as rent payments). Solving the criteria for qualifying assets may be reasonably straightforward. The REIT and MLP models already allow for the ownership of “real property,” which includes land and structure, and hence allows infrastructure ownership. However, the definition of qualifying income is a more complex issue. The REIT structure requires qualifying income to be in the form of a rent payment, and MLPs require either a rent payment or commodity-related income. This challenges the efficiency of owning infrastructure assets through REITs or MLPs, given the broad scope of infrastructure, the conventional pricing models for infrastructure assets, and the current interpretation of “rent” by regulators. Infrastructure involves more than simply commodity infrastructure and pricing, for the use of these assets is often articulated as a toll or a fee, which traditionally has not been viewed as a rent payment. However, it is arguable that payments made to use infrastructure represent a rent payment for use of the assets, irrespective of the exact pricing model and nomenclature used to describe it. For instance, in the case of an airport, about 50 percent of revenue comes from gate charges and passenger ticketing fees (the remaining 50 percent is traditional rents from retail and parking). Few would argue that an airport is not “real property” — it derives its value from the land underneath the airport, the runway and the terminal. So it logically follows that all fees and other charges paid by airlines and passengers are in fact to rent the use of this real property for a designated purpose and period of time. In the case of a gate charge, this is paid to give the airline the right to land its plane on the airport’s runway and rent the gate to disembark passengers. In the case of passengers’ fees, these payments are made to afford the passenger the right to use the terminal from the gate to the taxi line or parking garage. Similarly in the case of a road, this is also “real property” for which a tenant (driver) pays a rent payment (toll) to lease the property (the road) from the time it takes to move from point A to B.

Create an infrastructure investment trust: Another approach to create a listed infrastructure investment vehicle could be to leverage the success of REITs and MLPs as a blueprint for a purpose-built infrastructure investment trust. Such a structure could be designed to be specifically tailored to the characteristics of infrastructure assets, including the nature of qualifying assets and qualifying income.

Specifically, an infrastructure investment trust would define qualifying income to include revenues derived from the transmission, transportation and distribution of: 1) energy, 2) power, 3) data, and 4) vehicles (air, sea, road, rail). This definition would cover the ownership of electric, gas, and water utilities, telecommunication/data physical architecture, and both freight and passenger railways, airports, seaports, bridges, and toll roads. In addition, because much of our infrastructure investment requires new construction projects that may involve a period of no income and, in fact, losses from upfront investment, an infrastructure investment trust could feature the tax loss pass-through benefits of a private partnership structure, which cannot be captured in a REIT or MLP. An infrastructure investment trust that includes the ability to pass through tax losses to offset an investor’s ordinary income would create a powerful investment incentive from a broad base of investors. The effect of such a measure on stimulating new construction has precedent in the 1980s construction boom in commercial real estate.

CONCLUSION

New and better infrastructure is critical for the United States to maintain its competitive position in the global economy. Better infrastructure not only has the means to directly increase short-run GDP growth and provide employment for workers left behind in this cycle, but also improves the economy’s long-run potential growth rate. The challenges of funding and operating infrastructure in today’s economy require an enlightened approach to attracting private capital through the broadest base possible. A listed infrastructure investment vehicle, either through a de novo infrastructure investment trust structure or the expansion of current REIT/MLP structures, can draw on the precedent of successful existing listed structures that have opened opportunities in commercial real estate and energy investment to all investors. This would not only lead to the most competitive cost of capital available to fund U.S. infrastructure investment, but also allow the democratization of the ownership of our infrastructure.

Scott Crowe is chief investment strategist and Ted Brooks is portfolio manager with CenterSquare Investment Management.