Deloitte Sees REITs as Option to Fund Infrastructure Needs

Real estate investment trusts (REITs) could serve as the vehicle for a new wave of public-private partnerships to boost infrastructure maintenance and development across the United States, according to report (download here) by analysts at Deloitte. Such projects can range from toll roads and rail transportation to hospitals and prisons. In addition, recent Internal Revenue Service (IRS) regulations now allow REITs to invest in electric and gas distribution systems, providing yet another avenue for REIT investment. So-called infrastructure REITs could fill the gap between the financial demands for infrastructure updates and the limited funds available through the public tax coffers, Deloitte said. “Increased access to private capital through public-private partnerships would be a welcome complement to traditional infrastructure financing using tax-exempt bonds, and advantages of using a REIT structure over the traditionally-used fund model may be the right incentive to generate interest, “ said Lou Weller, a principal at Deloitte Tax. Investment sources tell HousingWire that investment strategies may shift away from municipal bonds, as the typical returns aren’t as high for municipal bonds as returns attained by REITs. In addition, there is increasing concern that municipal bonds aren’t as safe as they once were considered, as depressed property values and decreased consumer spending is resulting in lower tax collections, putting municipal governments as risk for default, according to the investor. However, the report said the pros outweigh the cons as REIT funding for public-private partnership projects are more liquid, provide for incremental scalability, easier access to capital markets and enjoy tax benefits. But critics argue the proliferation of such projects may result in higher costs for taxpayers and decreased accountability. In addition, critics argue once these projects get underway, firmly entrenched in the private sector, it’s difficult to bring them back into the public fold. “Because private-public partnerships are, first and foremost, commercial relationships, they are fundamentally changing the values and processes of democratic governments,” the Canadian Union of Public Employees (CUPE) said in a 2005 position paper. “Public-private partnerships are undermining democratic public institutions because the commercial relationships are inherently secretive, unaccountable and often very risky.” Deloitte also said there are downsides to using REITs in such arrangements. Most investments generate significant tax losses in the first 10 to 15 years of operation and these losses would not pass through to REIT shareholders as they would to partners in a traditional P3 arrangement. Also, Deloitte said if significant distributions to investors come from refinancing project assets, these would be taxable to REIT shareholders, even where there are no earnings and profits. In other public-private partnerships deals, the partners in a partnership would not face this treatment due to the ability to increase “outside basis” by allocating shares of debt from a partnership to its partners. Deloitte said there are other issues, including how REIT tax rules would impact the ability for infrastructure REITs to produce revenue. Under current law, no less than 75% of a REIT’s gross income must come from real estate rents. But it may be difficult for public-private partnerships involving toll roads, bridges, parking facilities, or transportation hubs like airports, seaports, or rail yards to qualify revenues as “rents from real property” under applicable tests, Deloitte said. Despite the limitations, Deloitte said some are looking for ways to use REITs in public-private partnerships transactions. Proposals include a legislative fix to create REIT-like Infrastructure Investment Trust (IIT) or a system allowing infrastructure assets to be owned or leased by a Taxable REIT Subsidiary (TRS). “If the use of public-private partnerships to fund, rehabilitate, or develop infrastructure continues to proliferate in the United States, the role of REITs will likely be examined more closely,” Deloitte said in its report. “REITs represent a well-understood vehicle to access capital markets and allow the public to participate in owning qualifying infrastructure assets, aspects which may be attractive to both the public and private sector.” Write to Austin Kilgore. Additional reporting by Jacob Gaffney

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