SAN FRANCISCO-Funding for infrastructure investment, along with every other real estate related category, took a big hit this past year with the collapse of the capital markets. Even during flush times, however, the category was perennially underfunded. That unfortunate confluence, along with some timely private letter rulings by the IRS recently, has prompted some innovative suggestions on how this ever widening gap finance can be filed. Larry Varellas, leader of Deloitte’s US Real Estate Tax practice and member of its infrastructure team, is one example. His suggestion? Publicly traded REITs dedicated to owning infrastructure. Describe, please, how this would work – and perhaps more importantly, why it hasn’t been tried so far.

Varellas: For starters, REITs would answer concerns about the private ownership of infrastructure — if it is publicly traded than anyone who buys shares in the REIT can own it indirectly. The problem has been that REITs have to meet stringent income and asset test rules to qualify for tax purposes. So some infrastructure might not qualify. But some can – like Greenfield projects where the revenue is structured as rent. Has this been done before?

Varellas: There are some REITS that own infrastructure now, like computer servers in the case of Digital Realty in San Francisco. Another example – railroad assets can be held inside a REIT. But those haven’t addressed the funding gap that much.

Varellas: No. But you think that may change.

Varellas: Yes. There was a private letter ruling from the IRS this year – ruling 37006 – which found that a gas pipeline transmission system might constitute real estate that could be owned by a REIT. So if the rest of that operation is structured properly to be compliant with the necessary rules it could be owned and financed by a REIT. There have been other IRS rulings as well, which find that certain utility assets are real estate that might qualify. Again, an encouraging sign. Are these rulings enough to encourage or support the type of structures necessary to fund investment.

Varellas: No. The point I am making is that now, with these rulings, some types of infrastructure – utility transmission for instance – can be held by REITs. But the government needs to consider legislation to broaden REIT rules to create more opportunities for REITS to own infrastructure that doesn’t currently qualify. Imagine if toll roads, ports, subway systems for instance, could qualify to be owned by REITs – it could be the perfect funding vehicle for getting this infrastructure built. Right now a toll road would be impossible to fall under a REIT – its revenue is literally coins paid by users. Do you think the political environment is ready for such a re-write of REIT rules?

Varellas: I don’t see why not. The major barrier has always been distaste for private ownership of public utilities or infrastructure. This answers that. What about investor appetite, especially now? Who would be interested in investing in a new, unproven real estate model?

Varellas: I think there will be appetite for these assets. Why not? It is a steady yield from an asset of which there is high demand – that is, a toll road or port. I think very much so.

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