REASON FOUNDATION
Executive Summary
Infrastructure asset recycling is a means of increasing investment in infrastructure, both existing and planned. The basic idea calls for long-term leasing of aging existing facilities to well-qualified private partners and “recycling” the lease proceeds into new (but currently unfunded) infrastructure.
In typical long-term leases, most or all of the lease payments are provided up-front. These proceeds are dedicated to investment in needed, but currently unfunded, infrastructure projects. Provisions in the long-term lease of an existing facility include performance requirements, which in most cases of aging infrastructure, will require significant additional private investment to refurbish and modernize the facility. Hence, asset recycling is intended to fix both of America’s serious infrastructure problems: aging and inadequate existing facilities and lack of funding for a large array of new infrastructure facilities.
Infrastructure asset recycling is being discussed today for several reasons. First and foremost, there is national concern about the poor condition and/or inadequate capacity of much U.S. infrastructure, which relates in part to a lack of readily available funding.
Second, there is a growing track record of state and local governments (which own nearly all U.S. non-military infrastructure) making use of long-term public-private partnerships (P3s), in which investors and well-qualified developer/operators design, build, finance, operate, and maintain (DBFOM) infrastructure facilities under long-term contractual agreements (35 to 70 years, typically). Most uses of this kind of long-term P3 have been to develop new (“greenfield”) facilities, but there are also cases of using this kind of agreement to refurbish aging existing (“brownfield”) infrastructure, such as the Indiana Toll Road and the San Juan International Airport.
Third, private capital is increasingly available for infrastructure projects of this kind. Global infrastructure funds have amassed hundreds of billions of dollars in equity to invest in DBFOM infrastructure, both greenfield and brownfield. Insurance companies and sovereign wealth funds are also starting to make equity investments of this sort. A newer player is public-sector pension funds, led by those of Australia and Canada. These investors and a growing number of U.S. pension funds are primarily interested in brownfield refurbishment, which is lower risk than greenfield projects.
Fourth, the White House infrastructure proposal is based largely on private-sector investment, for both aging existing infrastructure and new facilities. It includes important policy reforms that would widen the market for asset recycling of the kind discussed in this study. The U.S. DOT’s February 2018 document on how this policy would apply to transportation infrastructure devotes several pages to explaining asset recycling.
Australia’s federal government was the first to implement a policy to encourage state and local governments to engage in infrastructure asset recycling. It offered those governments grants of up to 15% of the proceeds from leasing existing facilities if the state or local government committed to using those proceeds for new infrastructure. Four of Australia’s states and territories took part, realizing a net A$20 billion from leases of existing infrastructure and garnering an additional A$6 billion in federal incentive grants.
U.S. experience with infrastructure asset recycling is more limited. The purest example is the long-term P3 lease of the Indiana Toll Road, which generated a $3.8 billion up-front lease payment. After paying off toll road bonds, the state funded a 10-year highway investment plan called Major Moves as well as creating a $500 million trust fund to maintain the new infrastructure.
Other examples, not all of which used the proceeds for new infrastructure, include:
- Chicago Skyway lease
- San Juan International Airport lease
- Bayonne, NJ water/wastewater system lease
- Maryland’s Seagirt Marine Terminal lease
- Ohio State University parking system lease
How much potential is there in P3 leases of existing U.S. infrastructure? To illustrate this, the author estimated potential net lease proceeds from the 61 largest airports ($250 billion–$360 billion), the 42 largest toll systems ($175 billion–$230 billion), seaports ($50 billion), water/wastewater systems ($110 billion), and state university parking systems ($60 billion). The total is $720 billion–$885 billion.
Several federal policy changes would encourage infrastructure recycling by state and local governments. One would be an incentive-grant program similar to that used successfully by Australia’s federal government. Another would be small grants that help those governments pay for financial and legal expertise to develop procedures to invite private sector proposals and to negotiate long-term P3 lease agreements. And a third would reform the existing narrowly focused program of tax-exempt Private Activity Bonds (PABs) to apply to more categories of infrastructure and to include refurbishment of existing aging infrastructure as well as brand-new facilities.
INTRODUCTION
WHAT IS INFRASTRUCTURE ASSET RECYCLING?
Recycling entails reusing or making something available for reuse. Applying the recycling concept to infrastructure “unlocks” the value of an existing infrastructure facility via a longterm lease to a qualified private-sector partner—and uses the proceeds to invest in new infrastructure.
Asset recycling is coming into vogue partly due to the existence of private capital that is eager to invest in existing (and new) infrastructure. Public-private partnerships (P3s) channel new capital and private-sector expertise to revitalize existing infrastructure as well as provide capital for governments to make new investments.
Infrastructure asset recycling can therefore deliver a double benefit to the public, addressing both aspects of America’s infrastructure problem. It generates new capital for investments to meet future needs, but also brings in a private partner who risks capital, creating incentives to properly maintain and rehabilitate aging infrastructure assets.
HOW DOES ASSET RECYCLING WORK?
Once a government has identified a list of suitable assets, infrastructure asset recycling has three interrelated components that promote a virtuous cycle of investment and renewal. The first element “unlocks the trapped value” of an existing (brownfield) infrastructure asset by leasing the asset to private investors through a long-term P3.1 The best candidates for these transactions are assets with an existing, self-generated revenue stream. It is the revenue stream that provides the resources and incentives for the private partner to invest in the rehabilitation and on-going maintenance of the brownfield asset. Public assets that do not have self-generated revenue streams, or those with limited operating history, are not good candidates for asset recycling.
The second component is that after the government has leased the asset, it “recycles” the proceeds from the transaction into new investments, ideally for other economically beneficial infrastructure. Some governments have used such proceeds for other balance sheet purposes, such as shoring up underfunded public employee pension systems. But the emphasis in this study is recycling the net proceeds to other needed infrastructure investments. To increase the impact of those investments, governments could the use the proceeds to procure new infrastructure development through “greenfield” (new construction) P3s.
The third component is that as the new assets mature and become good candidates for recycling (or as their long-term lease agreements end), government can repeat the process to enable continuous infrastructure investment and renewal.
WHY INFRASTRUCTURE ASSET RECYCLING NOW?
AGING INFRASTRUCTURE
The opportunity for infrastructure asset recycling stems from America’s current fiscal straits, coupled with the current condition of the nation’s infrastructure. There is broad consensus that America’s infrastructure needs significant investment across all sectors. In its 2017 report on the condition of America’s infrastructure, the American Society of Civil Engineers (ASCE) graded the condition of our infrastructure a D+. While some individual sectors fared better (freight rail received a B), others did worse (transit got a D-). Perhaps the lone bright spot from the report is that several categories saw slight improvements in their grades from the 2015 report card, while only three saw declines. Further, ASCE estimates that $2 trillion will be needed over the next 10 years to close the gap, meeting current and future needs while bringing existing infrastructure into good repair.
The ASCE’s estimates do not include a benefit/cost analysis of whether all the desired investments make good economic sense. But even more-conservative estimates agree that the challenges are large.5 The U.S. Department of Transportation (DOT) estimates that over $800 billion could be wisely invested in roads and bridges, including nearly $500 billion in critical repair work.6 Further, McKinsey & Company research suggests that additional infrastructure investment of $120 billion a year in 2017 (growing to an additional $150 billion a year by 2030) will be required to sustain U.S. economic growth.
The debate isn’t so much about how much investment is needed, but rather on how to pay for the investment. Fiscal pressure on the federal government in coming years will shift more of the burden onto state and local governments (which own nearly all the infrastructure discussed in this study). Many state and local governments are already struggling to adequately maintain their existing infrastructure, let alone find the resources to make new investments. And over the next several decades, fiscal pressures on state and local governments will continue to grow, as an aging population places increasing demands on entitlement and social service programs. Most state and local governments also face the problem of under-funded employee pension systems. As House Speaker Paul Ryan commented about addressing America’s infrastructure funding gap, “There’s no way we can tax you to pay for all of it,” suggesting that more than traditional public funding will be needed.
Meanwhile, many entities in the private sector—including capital markets, banks, public and private pension funds, financial institutions, university endowments, and insurance companies—have become increasingly interested in the infrastructure sector. Indeed, as part of their broader portfolios, many of these institutions have allocated capital specifically to invest in infrastructure. In addition, the growing number of companies that specialize in developing and operating P3 infrastructure also typically invest equity in projects for which they are selected. They bring to bear considerable technical capabilities and operating experience, enhancing not just the asset value but also the facility’s service to its customers.
Asset recycling is a way to capitalize on this interest. Leasing a revenue-producing asset under a long-term P3 agreement unlocks the value of the asset, providing resources for new projects that can enhance economic growth and productivity. Without “recycling,” the public investment in existing assets would remain trapped, and substantial private-sector capital would remain on the sidelines unable to make new investments. In that case, providers of that capital would seek to invest it in other countries instead of the United States.
This point is especially relevant to pension funds and sovereign wealth funds. Their risk tolerance generally does not extend to greenfield infrastructure; they invest almost exclusively in existing, or “brownfield,” infrastructure with a long, proven record of users and revenues. Asset recycling therefore opens the door to whole new categories of infrastructure investors.
ESTIMATED OVERALL INFRASTRUCTURE ASSET VALUE
How much value might be tapped from existing public infrastructure? An August 2015 report from McKinsey & Co estimated that the world’s infrastructure stock was valued at an estimated $48 trillion.9 Certainly the U.S. share is a small fraction of that value, but the fact that state and local governments own valuable revenue-generating assets—whether currently profitable or not10—is very attractive to private investors. Jill Eicher of the Bipartisan Policy Center reports that “estimates of the potential value to be realized in the U.S. through recycling of existing revenue-generating assets exceed $1 trillion.”
Infrastructure attorney John Schmidt of Mayer Brown estimates the realizable asset value of just toll roads and bridges could approach half a trillion dollars. He points out that the recent re-concessions of the Indiana Toll Road and Chicago Skyway (totaling over $8.5 billion) were for toll roads representing less than 2% of all U.S. toll revenues. So toll facilities alone could yield $450 billion. Adding airports, seaports, water systems and parking facilities could well yield a total exceeding $1 trillion, he estimates.
Of course, the true value of U.S. toll roads, ports, airports, bridges, water systems and parking facilities—to name a few asset classes—will depend on the assumptions used by investors and the governing policies established in the long-term P3 lease agreements.
Download full version (PDF): Asset Recycling to Rebuild America’s Infrastructure
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Tags: Asset Recycling, DBFOM, infrastructure asset recycling, Infrastructure Investment, long-term leasing, P3s, Pension Funds, Public-Private Partnerships, Reason Foundation
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