Infrastructure – The New Dimension in Real Estate Market Analysis
This is Part 10 of a multipart series, please see past posts for context – Part 1, 2, 3, 4, 5, 6, 7, 8, and 9. Visit JharrisPHD.com for all past articles, biographical information, and photography portfolio.
Infrastructure and Real Estate Values and Returns
When assessing the value of a site, for any use, there are at least three common factors to consider. First, proximity, what and who is near (sometimes this is called demographics or trade area analysis). Second, accessibility, how can the site be reached via primary and second modes of transit (think walk, drive, train, air, etc.). Third, visibility, how easily can the site the buildings built upon it be seen and recognized by those it hopes to attract as tenants or those tenants’ customers. All are a function of the quality and availability of the infrastructure that serves any given site. Thus, if the infrastructure fails or declines in quality and usability, expect the value and investment potential of the property to do the same. The real estate industry needs to recognize this fact and factor it into investment and development decision going forward as the US is facing greater and greater risks of failing infrastructure.
Infrastructure Defined – Hard Linkages & Services
When the word infrastructure is invoked, it is commonly used to refer to the network of roads, bridges, rail, and airports that serve a community. Additionally, services such as water, sewer, garbage disposal, and electricity are added to the mix but typically less discussed. In the modern world, availability of high-speed internet (and soon 5G wireless) is now also a critical factor (how much work would you do on a given day if you lost all internet connectivity?). According to the American Society of Civil Engineers, the US currently scores a D+ overall; however, without an estimated $3.6 trillion dollar investment, this score (and resulting services) will only get worse over time. Many major cities in the United States, such as New York City, are experiencing mounting delays in public transit and ever slowing road traffic. For a quick example, the average speed traffic moved in Midtown Manhattan fell 21% between 2010 to 2016 (9.1 mph to 7.2 mph); while that may not seem dramatic, it compounds to a huge problem. Thus, NYC and other cities face a risk of falling rents and values on a relative basis as service degrades; investors should factor this into investment underwriting.
Infrastructure Defined – Human Services and Aura
A less common, but equally important, component of a city’s infrastructure is its level and quality of human services and the general aura and state of being of the citizenry. Human services include critical elements such as public schools, medical care, social care, and police and fire services. It also includes government functionality; i.e. how hard is it to get a new business permitted and opened? Finally, it includes the hard to quantify but easy to identify factor of aura, or well-being and happiness of the residents. School quality has long been a known determinant of housing prices but it also determines where firms may choose to locate employees. Overall, if the livability of a city declines, people will want to move and that will cause businesses to do the same; the result is lower rents and property prices. As with hard infrastructure, investors should monitor and factor the quality of these services when analyzing markets.
Infrastructure Scoring – A New Requirement in Real Estate Investment Analysis
The rating and rankings of markets has been a constant theme since real estate became an institutional asset almost 40 years ago. Typically, markets are categorized as Primary, Secondary, or Tertiary using size and scale (see prior post for deeper discussion of the matter). It is arguable that an alternative or additional rating and ranking should be added, that being an infrastructure score or IS. An IS would give categorical if not numerical/qualitative comparative rankings to markets based on the level of service and condition of the infrastructure components listed herein. This is non-trivial, this method may have allowed investors to detect why markets like Denver, Orlando, and Austin would move up so dramatically faster than similar sized peers 20 years ago. It also gives a pathway to a quantitative means to adjust for relative risk and return profiles of traditional primary vs. secondary markets; a hot debate in many institutional investor and developer circles. In short, making investment or development decisions without thinking of the IS of a site could lead to higher than expected long term risks.
Solution is an Opportunity – Public-Private-Partnerships are the Only Option
With needs in the multiple trillions just to maintain and repair current infrastructure, let alone fund future growth and expansion, it is plainly impossible to imagine a scenario where any combination of federal, state, and local government funding and leadership is sufficient to meet the challenge. Public debt is too high, taxes cannot be raised anywhere near enough, and frankly, governments too often lack the skill and long-term vision that is needed. The answer is Public-Private-Partnerships or P3s. A P3 involves the capital investment and/or hiring of private sector enterprises to manage and control public infrastructure assets. P3s can build roads, airports, trains, school, hospitals, even parks. There is currently a glut of capital in the world seeking investment opportunities, thus the persistence of very low long-term interest rates. With some insightful public leadership, these vast stores of capital can be accessed to deliver improvements to cities and their citizens while providing sufficient returns to investors. Most of the New York City subways were built privately as were many bridges and other iconic American infrastructure assets (the Golden Gate Bridge was a P3). As such, there exists great opportunities to create infrastructure investment funds and deploy nationwide; the upside is stable, safe returns and being part of the solution to a nationwide crisis.
Real estate investors and lenders can be accused of being too short term in focus and thinking. Given that proformas of US based investors often only extend 5 to 10 years into the future, there is too little incentive to think about multi-decade risks. Unfortunately, there are likely to be true failures of major infrastructure systems in the upcoming decade; the result could be devastating for certain assets and markets. Investors and developers need to understand infrastructure risk and consider developing or adopting Infrastructure Scores to their underwriting models. Further, if looking for new places to deploy capital, consider investing into P3 projects; it’s a great way to earn a return on investment and help the country function better.