Right off the bat: I’m a firm believer and committed investor in vital infrastructure. Railroads, ports, pipelines, wireless towers, gas stations, airports, roads, electricity transmission lines and stations, you name it. For clarity – while the land that carries it, is not technically infrastructure itself, usually they’re bound together by decades-long leases (or short term leases that give more power to the landowner) that effectively make the ground underneath a senior tranche in the asset. More on that below. The majority of my portfolio is invested in land with infrastructure, but my appetite is insatiable.
What makes (proper) infrastructure a great investment?
In two words – low risk. To break it down a bit:
- Long term business model. It provides a necessary service to large groups of people and businesses, and usually takes a large upfront capital investment to build out, so it’s not going away any time soon and will be extremely difficult to outcompete. It has a huge moat, to borrow from the classics.
- Predictability of cash flows. Serving the basic needs of huge numbers of customers, the cash flows of the assets are extremely predictable with low volatility. So it’s easy to model revenues years out, at least compared to “regular” businesses.
Why is the land underneath infrastructure an even greater investment?
Three words – even lower risk:
- Senior tranche of an already low risk asset. If the infrastructure asset and the ground beneath it have different owners, their relationship is usually governed by a long term lease. This agreement can take on many different forms in different jurisdictions, like an easement, right of way, ground lease or others, but it essentially boils down to “I pay you X each year for Y years and in return get to own and operate the asset on your land.” A relative fixture in these types of contracts is, that the lease amount paid to the landowner is a fraction, sometimes a tiny fraction of the EBITDA of the infrastructure asset above it. This has the effect of shielding the landowner from the already low, but still possible volatility in the infrastructure asset’s earning power. An example situation would be, that a pipeline company pays the landowner a yearly fixed sum that amounts to about 10% of the pipeline’s EBITDA. If for some reason the pipeline’s EBITDA should shrink significantly (eg 25%), then all parties involved will survive, but the pipeline’s owner will suffer, while the landowner is still fine with a still significant margin of safety. This is why land underneath infrastructure assets is essentially a senior tranche in those particular assets.
- Lower barrier of entry and decent upside potential over time. The landowner’s cash flow being a small fraction of the entire asset’s earning power carries with it a somewhat stealth appreciation potential. To take the previous example of the pipeline, since the lease payment is small compared to the total earning power of the asset, the price of the land tends to be quite small as well, compared to the value of pipeline above. Near the end of the contract, if there are no lessee extension rights stipulated and considering it’s extremely expensive to construct new pipelines, a reasonable landowner can assess the earning potential of the pipeline and can probably substantially improve lease terms, which in turn will undoubtedly increase the value of the land. A new contract, more reasonable and fair toward the landowner (in reality, merely less tilted in favor of the pipeline’s owner), will in all likelyhood not prompt the pipeline’s owner to seek prohibitively expensive alternatives.
Infrastructure in general has been and will continue to be a good investment over time. The land beneath it is just a limited upside, protected downside tranche of it with a much lower barrier of entry.