Greenfield assets give higher, more sustainable yields than brownfield

Martin Lennon, co-founder and head of Infracapital, says that greenfield projects, if managed correctly, can be a better bet for institutions than more tightly priced brownfield assets.

Many aspects of our day-to-day lives rely on different types of infrastructure. They are the foundations of economies, spanning water and waste management, transport, energy generation, communications and social amenities. And as societies develop and economies grow, the need for new and better infrastructure continues.

A key driver behind the increased demand is mass urbanisation. Of the EU population, 75 percent lives in urban areas, placing additional pressure on ageing infrastructure. The building and upgrading of cities is crucial to accommodating the broad shift away from rural areas.

Another key driver is the increasing focus on sustainability and addressing climate change by transforming transportation and energy generation to adapt to a low-carbon economy. Significant investment is required to support the roll out of new technologies in the context of an increasing transition towards smart cities.

The European Investment Bank has estimated an annual need of €335 billion between now and 2030 if Europe’s infrastructure demands are to be met. However, fiscally constrained governments and companies generally do not have enough funding.

This is where institutional investors are starting to step in. These assets, if managed appropriately, can generate stable and reliable cashflows long-term.

There is strong political support for this. Governments across the EU are creating legislation and incentives to encourage and facilitate private investment in this new greenfield infrastructure.

Higher yields

Over the years, pensions and similarly long-term investors have shown an increased appetite for infrastructure as part of their search for resilient, inflation-linked cashflows.
Demand for operational brownfield assets, typically regarded as a lower-risk entry point into the asset class, has soared as more institutions now see infrastructure as a core part of portfolios. However, this increasingly competitive market is pushing brownfield asset values up and yields down.

“A key risk at the construction phase is that revenues or costs could be materially different than expected”

Only modest amounts of capital have flowed into greenfield infrastructure, given that pensions see it as a relatively new way of investing. But by providing access to infrastructure earlier in the asset cycle, greenfield investment can result in more attractive yields in the operational phase compared with traditional brownfield investment.Greenfield assets also appeal to investors as it can bring clear benefits to the economy.

There are three main stages to the evolution of an infrastructure asset. The first is the higher-risk development phase, which begins with the designing, planning and obtaining of consents and licensing. The second is development and building. The third takes place when the asset is operational and is a steady-state brownfield asset that can last for 25 years or more.

Allocating money at the late-development stage or the construction phase gives institutional investors the opportunity to earn returns that are several hundred basis points higher than for an equivalent brownfield project.

As each asset moves from construction to operational, it typically starts to draw in a predictable revenue. This, in turn, rewards equity investors with a higher yield than for a brownfield asset purchased at a premium.

Long term, investors are compensated for foregoing yield in financial close and operational launch. Whereas, buying in later to a brownfield asset may cost a lot more to access it and its income stream, thereby reducing overall yield.

A keen brownfield market also presents the opportunity for institutional investors with a shorter hold period to dispose of assets in the early operational phase, with a view to get a substantial capital gain.

Mitigating risks

Greenfield infrastructure is not without risk. Asset managers must have robust processes to monitor, structure and manage it. Effective cost management, allowance for timetable and budget overruns, as well as careful structuring of contracts are all important risk-management techniques.

Risks such as regulatory or political change, could be problems. However, this can be mitigated by focusing on contracted cashflows, supply-demand dynamics and strong counterparties. But, given the infrastructure funding gap, most governments will hold on changes that could discourage private finance.

Diversification can also mitigate risk. Infrastructure subsectors have different characteristics and risk level, so looking across a range of market subsectors and geographies is key.

Platforms can also help. One example is Infracapital’s investment in Bioenergy Infrastructure Group, set up to invest in the construction of UK biomass and waste-to-energy plants.

A key risk at the construction phase is revenues or costs could be materially different than expected. Platforms like BIG – now one of the largest of its kind in the UK – involves investing gradually in firms that have lots of projects over time, rather than to single large-scale projects that may be exposed to higher individual risks.

In addition to diversifying construction risk, this creates a portfolio approach to deployment, seeing earlier yield and the opportunity for operational synergies.

Seeking to contract revenues and costs can also mitigate risks in the construction phase by providing greater stability.

An asset manager with relevant greenfield expertise will be best to partner developers to access opportunities early. It will be able to take on risk only when it is confident a project is economically investable, while also having the toolkit of risk-mitigation at its disposal.

By hitting that sweet spot in later development and construction, a premium return is available, if risks are mitigated properly.