17 / 03 / 22 - 0 minute read
Episode #2 of the PAT Cast examines what makes social infrastructure different from real estate, the factors that are fuelling increasing demand in the sector, and the ESG and financial returns which are making it such an attractive asset class to investors. In this episode, PATRIZIA's Head of Infrastructure Graham Matthews is joined in conversation with Benjamin Thorsen, CEO of Kinland, a leading social infrastructure investor in Europe.
PAT Cast #2: Why invest in social infrastructure?
Ed Whittaker: Social infrastructure forms the backbone of any sustainable community. Yet investment opportunities in the sector have often been overlooked. So how is that picture changing?
Graham Matthews: These assets are a fundamental part of ensuring that the people living in communities are happy and safe and that we do have sustainable communities.
Ed Whittaker: I'm Ed Whittaker, and a warm welcome to the PAT Cast, the podcast from PATRIZIA, the leading investment manager and partner in global real assets. In this podcast, we offer you insights on a range of hot topics from the real assets industry. From important sector trends to key business developments and strategic decisions.
Today, we're taking a deep dive into social infrastructure, the sector responsible for keeping our towns and cities running and answering the simple question, why invest?
Benjamin Thorsen: Our strategy is at the heart of social infrastructure.
Ed Whittaker: That's Benjamin Thorsen, CEO of Kinland, a leading social infrastructure investor in Europe.
Benjamin joins our conversation alongside Graham Matthews, Head of Infrastructure at PATRIZIA, who you heard from right at the beginning. Now's the perfect time to have this discussion, as social infrastructure is high on the agenda at this year's Infrastructure Investor Global Summit in Berlin. So let's find out what it is and how it differs from real estate. Here's Graham...
Graham Matthews: I think the best way of thinking about social infrastructure is that it's a physical asset. That's used for the provision of an essential social service. And what differentiates that from real estate is really the regulatory environment in which that social infrastructure asset exists. You know an office or a shopping centre, clearly are commercial endeavors, whereas social infrastructure assets are used for the provision of a public service or a public good, as opposed to a private service or a private good.
And I think that's the key differentiating factor.
So Benjamin, what assets would you say are classified under the umbrella of social infrastructure?
Benjamin Thorsen: Well, the social infrastructure space is growing both in size and segments. In our view, we think primarily of educational properties and care properties for the educational sector, you would predominantly have daycare and schools as well as universities.
And then there is the care sector which will continue to grow substantially with a rapidly aging population. As well as increased privatization of the sector. Some would also include judiciary buildings and public properties such as public welfare administration under the social infrastructure umbrella.
And then there are assets that aren't commonly thought of like sports stadiums and fire stations, which we have seen transaction examples of recently.
And what role would you say these essential services play in creating smart, sustainable, and attractive communities?
Graham Matthews: Think about the sectors, that we're talking about sort of education childcare, the health sector, they’re obviously services that are important for communities. They're essential to daily life.
It's a fair thing to say that in a modern sort of Western society, we just can't do without these sorts of, of assets.
Benjamin Thorsen: Yeah. And we have seen this in various, uh, social infrastructure sectors. You take daycare, for example, where we are seeing increasing technical requirements to ensure that the needs of the users are well taken care of.
And we also see it very much within the care sector as well. Technology is playing an even more important role than before in terms of improving wellbeing within the last stages of a person's life.
It's interesting what you say there around digital aspects. There's quite a lot of emphasis around digital infrastructure in creating smart cities, but are there any good synergies between good digital infrastructure and also social infrastructure in creating a proper smart city?
Graham Matthews: I think that there's definitely interconnectedness there. So you think about, for example, the ability to provide healthcare services, between locations and to make, the existing use of, for example, a hospital facility more efficient. Being able to supplement on the ground resources with virtual resources, using smart infrastructure.
So connectivity, I think is important. There's the ability to have remote diagnosis of conditions. We can use technology and smart infrastructure to be able to deliver educational services remotely, to leverage up the capacity of existing physical facilities. So I think there's definitely an interrelationship there.
For some people, it might be a relatively new area to consider investing in. When would you say social infrastructure first started attracting private capital?
Graham Matthews: Interestingly, social infrastructure was actually one of the first areas of private investment in public infrastructure. The first investment that we made in social infrastructure was about two decades ago in Mildura Base Hospital in Victoria, Australia.
So it's been a sector that's actually been around for quite a long period of time, but what's been really interesting is to see how there's been just so much more interest in social infrastructure, from a private investing perspective over the last few years.
Benjamin Thorsen: I think that's a very important part of it, Graham.
And if you take Norway and the Nordics, as an example. Just 10 or 15 years back daycare was a relatively niche segment. It was very few transactions and very little division between the operational and property ownership part of it. But over time, it has become increasingly institutionalized with much more liquidity, which of course has affected pricing as well.
And over the last few years, we've seen a very rapid development, both in pricing, but also quite notably on transaction volume. You take one of the core markets, one of our core markets, Finland, for example, some years ago, social infrastructure was a very low part of the overall transaction volume. But last year, and also driven very much by the effects of COVID-19, it was up to 20% of total real estate investments, which is an incredible development.
And how mature is the market in Europe and globally, would you say?
Graham Matthews: I think that varies quite a lot between different countries. The private provision of social services through social infrastructure is more developed in some countries in Europe than it is in others. The Nordics, obviously that Benjamin can talk more about shortly in respect of Kinland has been a very positive area for us, quite a mature market, but a market where there's significant opportunities for new investment. Other countries in Northern Europe, are similarly placed. The UK as well. So across the world, Europe is one of the more advanced jurisdictions in terms of social infrastructure, which I think from an investor perspective, you know, being based here in Europe is a really attractive proposition.
Within the sub asset classes in social infrastructure, are certain assets more developed with greater opportunity for growth than others?
Benjamin Thorsen: Yeah, I would say there are still lots of opportunities in the daycare sector. But also, if you look at Finland, they have the most rapidly aging population inside of Europe.
And yet there is still very little private ownership when it comes to real estate. So you are going to see much more use of public private ownerships within that segment. Which will present lots of new opportunities for social infrastructure investors. And that is something we are monitoring quite closely.
Ed Whittaker: So we've learned more about what social infrastructure is. It's your schools, care facilities, fire stations, the buildings and services that are essential in creating our smart cities and sustainable communities. But what is the business case for investing in the assets that provide these public services? And what makes now a good time to invest?
Graham Matthews: I think it's really interesting to see just how much more attention there has been on social infrastructure over the past few years. And I think there's a number of reasons for that. One is that that social infrastructure offers investors the ability to invest in infrastructure that's very safe and secure that provides a strong cash yield, and also aligns very strongly with a responsible investment ESG framework.
I think the experience with COVID and what we saw, uh, having impacts on international markets, you know, having an investment sort of asset class that is so safe and obviously gets, it gets used sort of, no matter what's happening in the world has been a really interesting proposition for investors.
Benjamin Thorsen: Yeah. I think COVID-19 has really proved the resilience of this segment in a way that we can not have imagined before the pandemic. And that has really made investments into the sector much more attractive. And you see that public spending within social infrastructure in Norway has increased continuously.
And now, going into a period of another type of market turmoil, investors will once again be searching for, for those safe investment opportunities and social infrastructure really stands out in that respect.
Other than COVID, what are some of the other global trends that are driving demand for investment within social infrastructure?
Graham Matthews: I think there's a few things there. One is the increasing focus of investors and people generally on ESG and responsible investing. Because obviously investing in social infrastructure is a very direct way of improving social outcomes for communities. So I think that's been an important trend. Another trend is budgetary pressures.
So governments don't have the financial ability to deliver assets in the social infrastructure sector as they have in the past. In an environment going forward where budgets are going to be more constrained because of levels of debt that have been built up during the COVID period, there will absolutely be a need for - a greater need - for private investment in social infrastructure coming out of that.
And I think thirdly, another factor that's really led to increased investor interest has been around inflation. You know we are presently in a world environment where inflation is higher than what it has been in the past. And one of the advantages of social infrastructure is that revenues are basically linked to inflation.
So you have inbuilt inflation protection by investing in social infrastructure.
How important is it to have these strong public private partnerships within the social infrastructure sector?
Benjamin Thorsen: We see it as hugely important, critically in some sectors like education or care. There is a very large shortage of talent.
So having the private sector there, with the ability to attract and retain talent is going to be really important, both in terms of cost and quality aspects.
Benjamin, let's talk about Keenan's approach. Your company specifically focuses on providing highquality properties for government backed care services. Why do you take this approach?
Benjamin Thorsen: I think our strategy is at the heart of social infrastructure. While our operators are very strong, the ultimate counterparts are the municipalities, and that is government backed cashflow. I really believe in the strength of the Nordic economies in that respect. And, besides that, the properties that we acquire benefit from offering services with resilient demand. And they also benefit from very long leases with a very high probability of contract renewal, that limit downsides for us as landowners.
So, all in all, we believe we present a very strong investment case to our investors while also providing a very important societal need.
And I read very recently that Kinland acquired 12 social infrastructure assets in Finland. Can you tell us more about that deal and what you have coming up in the pipeline?
Benjamin Thorsen: Yeah. This was a portfolio of predominantly daycare units, as well as some very strong elderly care assets. So it's a deal which we think really resembles how Kinland looks now and how it will look in the future. And since we see daycare as such a quintessential part of the social infrastructure universe, we see a very strong and healthy pipeline for that sector, as well as opportunities in other care and educational facilities.
And Graham from PATRIZIA's perspective. What's the strategy when it comes to investing in social infrastructure?
Graham Matthews: So our focus, there's two things that underpin all investing that we do, no matter what the sector is. The first thing is a focus on, on core/core plus infrastructure where it's a true infrastructure asset, a real physical asset involved in an essential service.
And that clearly applies to the social infrastructure. And secondly, all of the investing that we undertake is underpinned by a very strong, responsible investing ESG focus. It's really interesting when you think about ESG, the first thing that comes to people's mind is the E you know, investing in solar and wind and other assets like that.
And, you know, the energy transition is a very important part of responsible investing and ESG, but it's not the only part. You know, this, investing in social infrastructure clearly fits within the S part of ESG and possibly more so than just about any other sub sector within infrastructure.
So our approach will be to continue to follow the investment philosophy that we have, continuing to focus on social infrastructure assets that provide an essential service in the various areas that we've talked about, around childcare and education and the health sector and law and order in particular, and look to do that on a global basis, focusing on OECD counties primarily.
Ed Whittaker: The ethical case for investing in social infrastructure is clearly strong, and this will only increase as the spotlight on ESG shines ever brighter. But what is the economic case and how exactly do investors generate returns from the sector?
Graham Matthews: You'd invest in social infrastructure because it's a safe and secure form of infrastructure investing. It provides a strong cash yield and inflation linkages on the revenue. And at rates of return that are very strong compared to say some elements in the pure real estate market.
So within social infrastructure we're generally looking at rates of return on equity investing in the sort of 7 - 10% range, which is quite, quite high. It's a good level of return, the risk adjusted return on social infrastructure, particularly the way we do it as PATRIZIA, is very positive.
And so therefore it's actually quite a good entry point for investors looking to enter into infrastructure investing.
And from a capital markets and capital raising point of view, do you find that social infrastructure is a bigger sell into capital markets versus other areas?
Graham Matthews: From a capital markets perspective, there is now more interest in social infrastructure, just like there is from an investor perspective, more interest in social infrastructure. So it's a sector that's gone through a period, 10 years ago, five years ago, where there was possibly less interest than there had been before that. And now we're starting to see more interest from equity investors and from debt capital market investors as well.
And from an investment perspective, what options are there?
Graham Matthews: So from an investor perspective, there's two ways of investing in social infrastructure. One is equity investing and the other is debt. From a debt investor perspective, it tends to be senior secured, close to investment grade, if not investment grade debt.
So returns are quite modest, shall we say, but for an investor, you know, maybe an insurance company looking for a way of accessing very low risk returns and willing to accept, you know, margins of, you know, a hundred and fifty, two hundred, two hundred and fifty basis points debt investing is possible.
But I think that the better risk adjusted return is actually on the equity side, on equity investing, because you can, you can get the 7 -10% type equity returns on an asset that even with debt in the capital structure is still very safe and secure because of the strength of the underlying cash flows for the asset.
And you've touched on it already, how social infrastructure clearly provides a very strong S in ESG. Is there ever a trade off between investing for financial returns versus ESG returns?
Graham Matthews: There's been a, sort of, a debate I guess, in investment markets more broadly for a long period of time about whether there's a trade off between getting the ESG credentials of an investment right, and returns. And, you know, in some areas, you know in listed equities or something like that, maybe there is a case, that there is a trade-off there, that to get ESG right you have to, at least for a period of time, accept lower returns. But if there is one area, anywhere in the investment markets where there isn't that trade off, it has to be an infrastructure and social infrastructure in particular. Because what we're talking about, your very long lived assets, your long investment timeframes, in some cases, physically large assets that can and do have, impacts on local communities, local environments, if there's any asset class where we're getting ESG, right, delivers better investment returns, it absolutely is infrastructure. And we see that day in and day out. If we don't get the ESG factors, right, it does come back and actually hit your returns. The flip side of that is if you do get ESG right, then you end up with enhanced returns out of infrastructure investing and social infrastructure in particular.
So when some people think of social infrastructure, they might think of an old fashioned community building or community center. So how does Kinland ensure it delivers the best in class assets for the community?
Benjamin Thorsen: Well, at all times we need to adhere to the standards as set out by the municipalities, which are getting higher and higher.
And we have a very close dialogue with our tenants and have very open discussions on how we can improve the buildings, to provide the best experience for users. So having that close interaction with our partners to make longterm plans, that benefits all stakeholders, we believe is critical.
And Graham, thinking of it with my real estate hat on, are there core plus and value add opportunities within the social infrastructure sector?
Graham Matthews: Yes there are. There's also ways of delivering that additional return that you'd get from value add opportunistic, but doing it in the context of an existing sort of platform. And that's exactly what we're doing in Kinland with Benjamin right now. You know, we, when we first acquired that portfolio of principally kindergarten daycare investments, that was, was it, Benjamin was it 170 odd properties, uh, facilities, initially, and over the past two years we've expanded that out to 250. And each time when we're making a new investment, bringing a new, facility into the Kinland platform, it's adding value. So you're getting, sort of, value add returns, but from the fundamental underpinnings of something, that's really quite core in nature in terms of the cash flows.
And final thoughts from both of you. Looking into your crystal ball, what does the next decade look like for social infrastructure as a sector?
Graham Matthews: You know, the next 10 years is going to be, I think, quite a positive experience for the social infrastructure sector, for the reasons that we talked about before. The increasing focus on ESG and responsible investing. The potential for inflation to be a bit higher than it has been.
In the past, the budgetary pressures that the governments are under, they're all things that will underpin positive investment opportunity and positive investment outcomes for investors in social infrastructure.
Benjamin Thorsen: What we see is that this is a sector that will experience much higher volume, generally much higher retention and liquidity.
And especially within certain segments. Not all segments are mature. So there is still potential to be found in certain sub sectors, particularly on the back of the megatrends that we see. Like the aging population and increased use of public private partnerships. All in all, we believe this will ultimately lead into some very attractive risk adjusted returns.
Ed Whittaker: Thank you to our guests, Benjamin Thorson and Graham Matthews. And thank you for listening. I'm Ed Whittaker and you've been listening to the PAT Cast from PATRIZIA. You can subscribe to the show on Apple Podcasts and Spotify or wherever you listen to your podcasts. And don't forget to head over to our website, patrizia.ag, to find out more. Stay safe and healthy, until next time.
This podcast is produced by OG Podcasts. Find out more at ogpodcasts.co.uk.