A properly diverse portfolio contains assets that are less correlated than bonds and equities. Traditionally, commercial property funds have provided a significant element of this diversification. I have argued for over a decade that infrastructure is less risky than these traditional property funds. Both should be considered carefully, as they require the deployment of long-term capital.
Understanding Property and Infrastructure Funds
Investors understand that a property fund will invest by buying and letting out properties for income and long-term growth. They primarily invest in offices, shops, and warehousing that are rented out to businesses.
Infrastructure funds, however, are less well understood. They invest in a broad range of assets that deliver services via tangible assets: roads, rail, cable, water, etc.
On face value, these share some similar features:
- Consist of tangible assets.
- Have easy-to-understand business models.
- Involve predictable cash flows.
- Provide long-term income generation.
- Both should provide some protection against inflation.
However, it is fair to say that the differences are significant, and generally, we would recommend a greater weighting toward infrastructure over straight property for the following reasons:
- Long-duration
- Long-growth potential
Long-Duration and Growth Potential
Both real estate and infrastructure projects are long-duration assets that provide income over long periods of time. Infrastructure generally has a longer and more active lifespan due to its essentiality. Assets like sewer systems or highways rarely fall into total disuse; indeed, they are often pushed well beyond their expected lifetimes.
Consider the railway lines: those built by Brunel are probably the best in Britain today, well over a hundred years later. Furthermore, scaling up capacity is often easier for infrastructure than for real estate. Real estate developers are limited by land-use restrictions, zoning requirements, and even engineering limitations. Infrastructure developers, meanwhile, usually can scale up as needed to accommodate additional users.
For example, toll roads can expand capacity by adding new lanes and additional on/off ramps or by introducing electronic tolling as the number of vehicles on the road increases.
Consumer Demand: Elastic or Inelastic?
There is a natural floor under infrastructure demand that does not exist in the real estate world. In real estate, consumers can, and do, put off buying new homes or renting new offices if the economy is not favorable enough. This elasticity is evident in the long-term shift by shoppers to online platforms and away from brick-and-mortar shops. Plus, COVID-19 forced many businesses to facilitate home working rather than occupying massive office buildings.
Consumers cannot go without water or power, regardless of economic conditions. Inelastic demand, combined with the scarcity of competition, gives infrastructure companies strong pricing power. A utility company, for example, can raise rates to keep pace with inflation or a rise in the cost of raw materials as needed, without meaningfully impacting volume.
Other infrastructure projects such as hospitals, prisons, and schools have far more secure tenancies than general property funds. This is because the agreements are much longer dated and fixed with underlying government or local authority support somewhere in the lease.
What this means is that infrastructure accrues steady, stable revenues, regardless of the economic cycle – which in turn means the potential for steady, stable income for investors.
Fewer Players in Infrastructure
Funding infrastructure requires incredibly deep pockets, whereas real estate requires less. Land can be relatively cheap and available, like out-of-town shopping centers and business parks. In contrast, the barrier to entry for infrastructure is high, especially for new projects or players.
Assets like new airports or railways require large, expensive tracts of land and may need several rounds of regulatory approval, sometimes across municipalities. Even repairing or replacing old infrastructure is no small feat. While you can always tear down an old office tower and replace it with a new one, that’s much harder to accomplish for old bridges or water pipes.
These costs add up: typically, an office tower can be built for tens of millions; a new road system or port terminal could cost tens of billions. Such significant costs inherently limit how many competitors enter any given infrastructure sector; many verticals end up self-organizing into natural monopolies or duopolies. With less competition, the few companies that do exist become entrenched, wielding significant pricing and decision-making power (though they also tend to be heavily regulated). The real estate market, in contrast, remains much more in flux, with no single company amassing monopolistic market share.
Fundamentals Drive Everything
Urbanisation: The U.N. estimates that 70% of the world’s population will live in cities by 2050. This bodes well for residential developers and essential service providers alike. However, in metropolitan areas, space is at a premium, meaning real estate developers will be forced to compete fiercely for land and zoning rights. Meanwhile, municipalities will likely prioritize infrastructure projects that can relieve congestion – e.g., light rail transit, toll roads – or increase access to essential services.
Energy Security: Historically, energy security has meant securing access to foreign oil deposits. In a world threatened by climate change, it also means building out clean energy infrastructure, including upgrading the electric grid to better handle renewable power. This will require massive investment in infrastructure, greatly benefiting companies in that space. Smart real estate developers may also capitalize on the clean power transition, but existing urban planning paradigms typically assume petroleum-based energy infrastructure, which will take serious rethinking to unwind.
Underinvestment: Residential and commercial real estate experience booms and busts but face no shortage of investment capital. Infrastructure spending, on the other hand, has languished for years. The Congressional Budget Office estimates that public spending on U.S. transportation and water infrastructure has declined 9% since 2003, even as these systems age and fall into disrepair. To address this need, the current administration has proposed $1 trillion in infrastructure spending over ten years, much of which will be achieved through public-private partnerships. The UK has long utilized Public-Private Partnerships (PPP) to fund new infrastructure.
To Recap
A properly diverse portfolio will contain assets that are less correlated than bonds and equities. Traditionally, property funds or infrastructure funds have provided a significant element of this diversification. They are long-duration investments with long-term growth potential.
While some properties may be more secure in the long run based on iconic locations, overall, we favor infrastructure funds over traditional property funds and weight our portfolio recommendations accordingly.
Disclaimer: Please be aware that investments carry varying degrees of risk, and as their underlying value can fall as well as rise, you may not get back the full amount invested.
