Social infrastructure an exciting asset class of the future

Social infrastructure is a hot topic with investors these days, but Nick Anagnostou remembers when it was a tough sell for fund managers.

“Ten years ago when I tried to explain it to investors, many of them would smile politely and said, ‘Thanks very much, but it’s not for us,’’ says Nick, who is our Head of Social Infrastructure Funds.

“But a lot has changed, and today many of those same people are our most trusted-on investors.’’

Social infrastructure can be broadly defined as the physical assets that underlie the social services needed to create strong communities, and includes real estate in the healthcare, childcare, aged-care and government sectors, as well as education facilities, social housing and student accommodation.

The change of heart Nick has witnessed in the last decade over private-sector investment in this space has been driven by a perfect storm of explosive growth in Australia’s population, coupled with stalling government capital expenditure on infrastructure.

Successive federal governments have effectively endorsed a ‘Big Australia’ approach to population in order to support economic growth. Yet short election cycles provide little incentive for long-term government planning of major infrastructure projects, and burgeoning demand for recurring expenditure such as social security and welfare puts pressure on capex budgets.

This situation has created attractive investment opportunities for private capital, says Nick.

“In Australia, we have a population that’s growing probably the second-fastest out of all 36 OECD nations,’’ he says. “Take Victoria as an example, which is experiencing anything up to 2.1 per cent annual population growth compared to around 0.8 per cent in the US the UK, or the OECD average of 1.2 per cent.

“To put that in real terms, that’s 680 families a week landing in Melbourne looking for somewhere to live. At the same time, a similar number are arriving in Sydney. The public purse simply can't afford to build the schools, the childcares, the hospitals we need, so private industry is filling that breach.

^{Image: Only About Children, Armadale, VIC}

“On top of that, populations are so dynamic these days that even if governments had the will and the money to tackle the problem, they simply couldn't act fast enough.’’

Apart from financially stretched governments, a range of demographic and social trends also conspire to keep the squeeze on social infrastructure. For example, our ageing population means increasing demand for seniors’ housing and health services. The greater participation of women in the workforce creates a need for more childcares, whilst record numbers of international students are causing a boom in demand for university campus facilities and student accommodation.

Increasingly too, Australians are demanding not only more but also better-quality social infrastructure. For example, the childcare sector developed from ‘child minding’ to early learning, changing the design and layout of centres away from converted houses to purpose-built facilities.

And there is a growing realisation that operators of social infrastructure should focus on their core business of managing and delivering services to the community rather than investing their funds and management time in the provision, ownership and management of the underlying real estate assets.

For investors, social infrastructure real estate has several appeals, including

• strong yields – these assets typically offer yields 100 to 150 basis points higher than those of major office, retail and industrial buildings;
• stability – social infrastructure assets typically exhibit low volatility and generate consistent cash flows, offer a low correlation with other asset classes and resulting in attractive diversification benefits for investors;
• attractive lease structures – a combination of long-duration initial lease terms of 10 years plus, inflation protection given that rental increases are typically linked to CPI changes, and a triple-net structure which means that all capital expenditure and refurbishments related to the asset are paid by the tenant;
• stickiness of tenants – tenants are inherently linked to their premises due, in many cases, to the specialised nature of the assets, particularly internal fit-outs;
• government support – social infrastructure sectors generally receive some form of government subsidies and/or payments;

Nick oversees the ASX-listed Charter Hall Education Trust, the largest Australian REIT investing in early learning properties in Australia and New Zealand. Despite its market-leading position, he says there is still ample scope for expansion.

“We think the investable universe for us in childcare is in the region of $4.5 billion, and we currently have $1 billion of it,’’ he says.

“There are over 7500 childcares in Australia, of which we currently have only 420. However as investors we only like particular locations, certain sizes and formats, and as that pyramid of opportunities rises to the top it becomes pretty pointy.’’

^{Image: Only About Children, Hawthorn, VIC}

The childcare industry in its current form dates back to a key policy decision by the previous Coalition federal government.

“In 1996, the Howard/Costello government decided they were going to fund the childcare user, not the operator. They would let the private market determine where it should put childcare centres, when and how, and they would fund the people who use the system.

“So it’s a bit like Medicare, essentially it’s a rebate. It is highly efficient, because if there is no demand in a particular location for a doctor or a childcare, the government hasn’t committed capital to building a medical centre or childcare that isn’t needed.’’

The central role childcare plays in the Australian economy is not always fully recognised. The importance of social infrastructure lies in the support network it provides for the economy, serving to release production capacity, and childcare is no exception.

“Childcare is essentially a labour supply mechanism,’’ says Nick. “All up and all forms of childcare, whether it be kindergarten, long day care, or before and after school care, they are 1.4 million children in Australian childcare today.

“Can you imagine if that was suddenly turned off for a month, the flow-on effects that would have through the economy?"

"Childcare is not a form of social welfare. It puts people back in a job, and for every $1 the government spends on it they get back about $1.80 in direct taxes.’’

Nick also oversees a second fund, the Charter Hall CIB Fund, a closed wholesale unit trust with real estate investments including government buildings such as police stations and law court complexes.

And through other funds of ours we also own social infrastructure assets such as 1 Parramatta Square, which is principally leased to the flagship vertical campus of the University of Western Sydney.

All current trends suggest opportunities for fund managers and investors in the social infrastructure space will continue to grow rapidly in the years ahead, says Nick, who sees multiple untapped opportunities for private-sector participation.

“Things have to have to head that way, not just in Australia but across the West and the OECD,’’ he says. “If you look at Western governments and the way they look after their assets, it’s clear that many are all falling to pieces because nobody has any money to spend on them. 

“In Australia, for example, there is no reason why we shouldn’t be building schools and leasing them back to governments.

“It's not going to happen overnight. We will have to raise it and pursue it in order for it to happen, instead of waiting for government to do something. It’s the kind of idea that we have to make possible.’’