This article is sponsored by PATRIZIA Infrastructure
Infrastructure, whether you’re talking about energy, transportation, water or various other sub-categories, has long been an attractive asset class for long-term investors. However, infrastructure needs are changing quickly as a direct result of the battle against climate change.
In short, vast swathes of infrastructure will have to be replaced, modified or newly created if the world is to have any chance of hitting net-zero carbon by 2050, or coping with the effects of climate change that are already assumed in various environmental models.
Certainly, this is a huge challenge. But it is also an opportunity, both in terms of supporting the pivot to low-carbon economies the world so desperately needs and generating attractive financial returns. At PATRIZIA, we believe those opportunities are particularly strong in the Asia-Pacific region – here’s why.
Attractive economic and demographic credentials
First, it has to be recognised that APAC’s infrastructure story is underpinned by strong economic tailwinds. Real GDP growth is robust, the region is seeing increasing urbanisation, and disposable incomes are also rising. All of these factors support increasing demand for infrastructure.
APAC’s demographic profile is also attractive. While much of the developed world is currently wrestling with how to cope with ageing populations and subsequently diminishing workforces, the picture is very different in APAC. Emerging economies in the region are expected to add more than 400 million people to their labour pools over the next 20 years.
This is expected to contribute to increased economic integration, something that has already been happening and was strengthened by the covid-19 pandemic. Indeed, the Association of Southeast Asian Nations recently overtook the EU to become China’s largest trading partner for the first time.
Increasing prosperity is another factor. With rising disposable incomes, APAC’s middle class is growing rapidly: its share of the global middle class is forecast to increase from 54 percent to 65 percent between 2020 and 2030, representing some 1.5 billion people – a remarkable forecast for a single decade.
“APAC is expected to account for around 60 percent of global urbanisation over the medium term”
Combined with rapid urbanisation, APAC is expected to account for around 60 percent of global urbanisation over the medium term; what this means is economic growth, the likes of which can only be envied in most other parts of the world. According to the International Monetary Fund, the region will see near-term GDP growth well above either Europe or North America.
In the eye of the storm
So there can be little doubting that demand for infrastructure in APAC will remain high. The challenge will be meeting that demand in a sustainable manner. After all, the region sits at the forefront of the global sustainability challenge, in terms of both cause and effect.
On the one hand, it is currently highly reliant on fossil fuels and accounts for more than half of carbon emissions. On the other, its high population density, environmental degradation and many coastal areas make it highly vulnerable to rising sea levels and to the increased frequency of extreme weather events the world is already seeing.
The problem is that APAC is currently considerably behind the curve when it comes to decarbonisation. However, the situation is changing. ASEAN energy ministers recently set renewable goals that will require around 35GW to 40GW of renewable energy capacity to be added by 2025.
In Taiwan, for example, the government has targets to increase wind capacity significantly by 2035. A number of nations in the APAC region have also committed to ending investment in coal power generation.
And yet, substantial challenges remain, not least the nascent state of the region’s renewable energy infrastructure. For example, grid infrastructure in many APAC countries is poorly configured for the variable output of renewable power. Fixing such issues won’t come cheap. Indeed, if APAC is to reach net-zero emissions by 2050, it is estimated that capital expenditure across the region would have to rise by around $1.0 trillion to $3.1 trillion per annum.
Inevitably, that means there is a sizeable funding gap between APAC nations’ spending power and the sums required, something that is not helped by high government debt levels. Indebtedness was already high as a result of the required responses to the global financial crisis, both in terms of bailouts and stimulus packages. This has been further compounded by the stimulus response required for the covid-19 pandemic. Furthermore, the recent increase in both interest rates and USD currency will further constrain governments given the dominance of USD debt financing in the region.
While APAC governments tend to be less indebted than those in Europe and North America, debt levels are nonetheless high. Indeed, Japan has the highest government debt-to-GDP ratio in the world. As a result, private sector investment will be required to bridge the funding gap, something that Japan has already acknowledged by encouraging privatisations, especially in airports and water infrastructure.
Infrastructure investors have tended to focus their attention on large, core infrastructure assets in Europe and North America. The resulting high levels of competition have led to a supply/demand imbalance, which has placed pressure on return projections in these regions. This challenge is reflected by the levels of ‘dry powder’ for infrastructure funds focused on North America and Europe: 47 percent and 44 percent of assets under management, respectively, as at October 2022. This suggests that competition will remain exceptionally high for assets in these regions.
“There is a sizeable funding gap between APAC nations’ spending power and the sums required”
By contrast, dry powder for APAC-focused funds is at a record low of just 24 percent. Fundraising activity across the region is also low relative to historical levels for the region. The funds that have been raised in APAC are also limited to a handful of managers who are solely focused on large-cap trophy assets, ensuring there is limited competition in the mid-market segment.
Major opportunity at hand
All of this presents a major opportunity for investors. With higher rates of economic and population growth, rapidly rising incomes and a steeper curve to achieve sustainability outcomes, emerging APAC markets offer an attractive investment opportunity.
Of course, as is the case in all investment matters, there are risks involved, not least in terms of navigating a myriad of legal and regulatory systems across what is a vast area. However, our strong view is that attractive opportunities for private capital exist across key areas.
These include, but are far from limited to: supporting a transition away from fossil fuels toward wind, solar, hydro and biomass; an expansion and strengthening of electricity grid networks to service renewable energy; and solutions to carry and store excess energy, such as lithium-ion batteries and hydrogen.
Indeed, PATRIZIA has already acted on our convictions. To take just one example, in 2013 we acquired Miaoli Wind, a 49.8MW wind power project comprising 25 turbines located in Taiwan, which reduces carbon dioxide emissions by around 140,000 tonnes annually.
Following substantial investment, the asset was exited at a favourable IRR in June 2020.
So, while the world as a whole requires a significant level of investment if it is to hit the net-zero carbon by 2050 target, some regions provide more exciting opportunities than others. In APAC, increasing GDP, the rise of the middle class and rapid urbanisation are together creating strong demand for investment in renewable infrastructure.
On the supply side, government debt and investor preference for North America and Europe mean there is a significant APAC funding shortfall. We believe this imbalance provides an opportunity to generate more attractive risk-adjusted returns relative to traditional infrastructure markets.