Europe needs to rebuild
The Organisation for Economic Development estimates that its 34, mostly European, member states will need to invest a total of $30 trillion in infrastructure by 2030. The European Commission’s Juncker infrastructure investment plan has targeted €315 billion over just the three years to 2017.
But with governments struggling to rein in spending, alternative sources of finance will be needed if these projections are to be met. For instance, the UK government’s infrastructure plan assumes private financing will make up nearly two-thirds of the country’s £411 billion infrastructure pipeline over the next five years. Yet British private sector infrastructure investment averaged just £4.6 billion a year between 2000 and 2010.
What is greenfield?
Rather confusingly, when infrastructure investors talk about brownfield and greenfield stages of a project, they don’t necessarily use the terms in the sense that some people know them. While in other areas the definition of greenfield is of an undeveloped site, usually either farmland or other form of greenbelt, in infrastructure investment, greenfield refers to the development stages of a project’s lifespan. Once it becomes operational, it’s known as brownfield. So a greenfield infrastructure investment will often refer to a project that’s being built on a previously developed, or brownfield, site.
The distinctions around types of ‘greenfield’ for infrastructure investors are important. Capital employed at a project’s earliest ‘Development Stages,’ usually within the first couple of years, is most at risk but also potentially posts the highest returns. As planning and other permissions are granted and financing is organised and construction begins, the ‘late development / construction stage,’ the average expected return for new investors declines at each point until, finally, the project goes live. From this point, most infrastructure projects then have an operating lifespan lasting from a decade to a quarter of a century.
Historically, pension funds have tended to invest in brownfield infrastructure. The very early stages, during which planning and other approvals are being sought, tend to be the preserve of specialist investors such as developers. But there’s a sweet spot during the later development period, soon before or during construction. At this stage, investors have early access to these attractive, predictable infrastructure assets at better expected annual average returns than were they to enter at the brownfield stage, yet with less volatility and more manageable risks than during the early development stages.
A manager that participates in project structuring prior to construction of assets, which typically lasts a year, will usually expect an internal rate of return in the mid to high teens, depending on project life. Coming in at construction phase could result in returns in the region of a few hundred basis points lower than this. Both would deliver a return well in excess of that expected on an equivalent brownfield portfolio.
For investors, the challenge to investing in projects at a greenfield stage is mitigating construction and associated risks. But even before they sign up to a project, greenfield fund managers need to have a good understanding of its regulatory and political background. Infrastructure projects are often politically sensitive because of their scale, longevity and significance to local communities and economies more generally.
Diversifying portfolios is another way to mitigate greenfield risks. Different infrastructure sectors have different characteristics and varying degrees of risk. For example, utility infrastructure assets often have resilient income streams and low correlation with economic growth. On the other hand, transport is more correlated with the wider economy and can deliver higher growth. A diversified portfolio that combines assets from various sectors and geographies is important in creating a balanced risk profile.
As Europe rebuilds over the coming years, private investors will increasingly be called on to fill a funding gap. As they do, they will look for the best risk-adjusted returns-investment sweet spots like greenfield infrastructure.
For further information about Infracapital, the infrastructure equity investment arm of M&G Investments, please visit http://www.infracapital.co.uk.
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