WASHINGTON — Real estate investment trusts could be the next frontier for infrastructure financing, according to a report released yesterday by Deloitte LLP, a member of Deloitte Touche Tohmatsu, a Swiss association. But legislation is needed to clarify questions of eligibility if public-sector entities want to secure REIT investments, the report said.
Currently, investment partnerships for infrastructure projects and assets generally follow a public-private partnership model wherein private investors or a fund enter into agreements with governments or other public-sector entities. The private-sector party provides compensation to the public-sector entity, and some service, often to design, finance, build, operate, or maintain a facility, such as a toll road. In exchange, the private-sector party takes responsibility for, and receives income from, the facility.
But as private investors search for new, tax-efficient investments and governments increasingly face infrastructure funding shortfalls, REITs could become a more favorable investment tool for infrastructure, the report said.
REITs are essentially funds that invest in real estate assets or mortgage pools without having any active role in the business. They are subject to Internal Revenue Code requirements, including that at least 75% of their income must come from real estate sources, such as rent or mortgage interest.
One big question that stunts the growth of REITs into the infrastructure market, according to Deloitte, is whether such things as utilities or highways and the income they would generate for REITs would qualify as real estate under Internal Revenue Service rules.
Federal legislation could clarify rules for the market by creating a kind of infrastructure investment trust that would include P3 revenues, or a system wherein infrastructure assets could be owned or leased by a taxable REIT subsidiary, the report suggested.
Legislation would “take off the table this problem of whether a form of infrastructure is or isn’t real estate,” said Lou Weller, principal at Deloitte Tax LLP, a subsidiary of Deloitte LLP.
The IRS issued two separate private-letter rulings in 2007 and 2009 that sanctioned the use of REITs to own electric and gas distribution systems, and those PLRs have prompted more interest in REIT involvement in infrastructure, according to Deloitte. The IRS said that utility transmission and distribution systems qualified as real estate as long as the REIT was not actually operating the utilities that were connected with the systems.
Private-letter rulings are issued on a case-by-case basis and are limited to the specific party requesting the ruling. The IRS cautions against viewing them as policy of the IRS or Treasury Department. Nevertheless, market participants consider them, particularly in areas where little guidance currently exists.
The rulings do “kind of signal the position of the government, and they are carefully reviewed by the government,” Weller said. “I wouldn’t say [the IRS assessment] was revolutionary, but it was certainly indicative of one way of employing a REIT.”
However, both legal and practical complications exist that could hinder REIT expansion into infrastructure. It could be difficult for P3s involving transportation, such as toll roads, parking facilities, airports, or rail yards to provide revenues that qualify as “rents from real property,” the report noted. REITs also may not be able to charge as much rent as taxable investors could, which would offset the tax advantage of such deals, the report said.
