REITs of Passage
Project finance. Corporate finance. Build-operate-transfer. Various
forms of leasing. All of these can, and have been, used in the
development of airports. But in the search for new project investor
bases ? given bank exhaustion from the telecoms and power markets ?
there is an untested alternative.
To date the real estate investment trust (REIT) has only been used to partially fund airports. There are advantages to using a REIT as a financing vehicle. The first is that a REIT can finance the entire amount of real estate, which is securitized, while debt only finances a proportion of the assets. In addition, financing payments are only made when the cash comes home ? so if you have no income, you don't pay off the financing. This cuts out the interest charges which are inevitable with debt financing.
Not only that, but you are looking at a whole new investor base.
?The benefit of using a REIT for this would be to access a different market for capital,? explains Bruce Kayle, a tax lawyer at Milbank, Tweed, in New York. ?It is entirely possible that someone could do it. Financial institutions that see the opportunity may want to do it. It is as much a pricing issue as anything else. Selling interests in a REIT would involve a different investor class than you would otherwise go to for an airport.?
REITs in the US benefit from the tax laws, which allow them to deduct tax depreciation when calculating their income ? which airports are not able to do. No tax is payable at the REIT level ? the only tax liability is for the share or unit holders when they receive their dividends. And REITs are a particular favourite with the US capital markets.
?REITs are accepted by the capital markets as they look, and act like a corporation,? says David Right of Hunton & Williams. ?In a way they are better, as the markets know that they act in the interests of the investors. The management structure is accepted by lenders.?
However, there are drawbacks. A REIT must make the vast majority of its income from rental. REITs are required to be passive, and may not operate an airport; they can only own it. In the US, from January 1 2001, however, the law is changing to allow REITs a little more flexibility, and from then subsidiaries of REITs will be able to operate from the real estate, although income tax will apply.
Kayle agrees that the tax and ownership status could involve some complicated work. Although there are two options for potential airport owners: ?The REIT either would have to be a mere lender to the operator of the airport, or could own the airport, provided that it leased the airport out under a triple net lease.?
One of the more problematic issues for using REITs ? and one of the reasons it has not yet been used ? is the fact that it is a US structure, based on US tax law, and US airports are publicly owned. However, other countries have implemented similar laws, including Japan, the UK, and several other western European countries.
A source at a US company specializing in REITs explains: ?There are different challenges in different countries, the tax laws for example. Can you restructure the investment and repatriate the capital without tax leakage? I don't know of any hurdles specific to airports, but you would have to lease the real estate to an operator, and you would have to bifurcate owning and operating, which may be an additional issue under US REIT laws, but it does depend on the country.?
AMB is the biggest owner of airport real estate in the US and came close to financing an entire airport through REITs. What stopped it was not the impracticality of using the vehicle, but the fact that it changed its strategy and decided it wanted parts of airports, not whole ones (AMB is nevertheless the seoond largest REIT in the US). And according to Blake Baird, head of investment at San Francisco-based AMB: ?The structure could finance a wide variety of airport buildings.?
He adds that some REITs are considering financing a whole airport infrastructure, but it has happened yet for a variety of reasons. ?Airports need a whole lot of capital. Our company has $4 billion in assets. To own a whole airport would take up too large a percentage of our assets in one facility, and it would take up too much capital. The infrastructure costs on an airport could go into billions.?
AMB has been looking to buy property outside the US for 18 months but, ominously, ?we haven't found the right tax structure? adds Baird. If the country's tax laws are compatible with the vehicle, however, one option would be to use a hybrid structure, where part of the buildings of the airport are owned by a REIT, while other forms of financing continue to be used in the project.
Kayle agrees: ?It may be that you could do one part of it through a REIT, if the whole thing turns out to be more than the market can absorb.? But whether it would be worth the heavy transaction and documentation costs associated with breaking the mould on a financing structure is unclear. That road may be better trodden once someone has already used a REIT to finance an airport for the first time. And when will that happen?
?I would not expect to see REIT finance happening in the near term for airports,? says Baird. ?Airports are more likely to be funded through collaberation, or perhaps through a consortium.? Kayle is slightly more positive. ?It's an economic question,? he says. ?It would depend on the pricing and the transaction costs. At the end of the day, it's a market call.?
A privatization alternative?
But with the spate of privatizations coming up in western Europe, it may well be an advantageous time to be looking at different structures, and different sources of capital and investors.
A consortium including Flughafen Frankfurt-Main has recently won the Peruvian government's concession for operating and expanding Lima's Jorge Chavez International Airport, as part of its stalled privatization programme. The consortium also comprised Bechtel Enterprises, which, like Frankfurt holds a 42.75% stake, and Peru's largest construction firm Cosapi, which owns the remaining 14.5%. The consortium must invest at least $12 million each year in the first two years, and a second runway has to be built within 11 years. The Peruvian government was hoping for investment of $100 million in the first three years, and $550 million within 10. Frankfurt beat off competition from three other consortia, led by Vancouver Airport, Vienna Airport and Spain's Aeropuertos.
Robert Payne, head of international press for Flughafen Frankfurt-Main, is reticent over the details of the group's financing plans, but admits he is hopeful of the outcome of Frankfurt's own privatization to help raise capital for the project. ?We are planning an IPO for the summer of 2001, which is, obviously, dependent on market conditions. But of the money raised through our partial privatization, some will go to finance expansion at Frankfurt itself, and some will be used for our global expansion ? part of which includes Peru.?
Frankfurt's IPO may be blown slightly off course by German airline Lufthansa's recent announcement that it is to develop a second hub at Munich. Although Frankfurt's expansion will go ahead as planned, investors may be concerned by the news.
They may also become tired of the number of share offerings and IPOs on the market. Grupo Aeroportuario del Sureste, the Mexican airport operator, is planning to raise $400 million from its IPO on the New York Stock Exchange. And Swiss operator Unique Zurich issued a secondary offering of 1.2 million existing shares in November, led by CSFB. Pricing for the shares opened at Sfr250 ($141) and closed at Sfr282. The offering was successful, despite market concerns that the next wave of privatizations may cause investors to become wary of the sector.
Privatizations, or partial privatizations planned for this year include Amsterdam Schiphol Airport, Zurich, Brussels and Vienna. A recent report from Standard & Poor's warns of potential problems ahead for these airports, as they try to satisfy their new shareholders, increase traffic by offering discounts to airlines, and raise finance for new airport projects. Both London Luton and Aer Rianta have fallen foul of their incumbent airlines by cutting back aeronautical charges, only to raise them significantly once the carriers are well-established. Although airports have a relatively stable income, it is likely that the newly privatized European majors will start to leverage up their balance sheet, because of regulatory price setting requirements or concern over shareholder dividends.
But some do not seem to be so worried about their financing commitments, or leverage. Frankfurt's Payne says: ?Raising money is not a problem for us. The banks are knocking at the door.?
Other airports still in the stages of privatization cannot afford to be quite so bullish. According to local press reports, Pietersburg International Airport in South Africa, privatized just six months ago ? is on the verge of collapse. The government awarded the 50-year concession for the airport to a Malaysian company, Onstream Services, despite a warning from adviser HSBC that the company was not sufficiently financially transparent. Onstream had pledged an initial injection of R5 million ($563 million) but has been unable to source the required capital for the airport, which has run at a loss for over four years.
Let that be a warning to the next spate of African privatizations, which include Maputo Airport in Mozambique. Bidding for the airport has begun, for a 12-year concession for operating and modernising. The airport is estimated to need some $25 million, and in exchange the winning bidder will be able to manage and operate it. An announcement is expected in the first half of next year.
Any bidders may do well to look at the example of Baku Airport in Azerbaijan, which has just secured funding from the UK's ECGD. The ECA is to offer $30 million to build a new cargo terminal, with a 12-year term and 7.4% annual interest. The loan is expected to be repaid within 10 years. The airport has also attracted interest from KfW which is considering offering finance to rebuild the runway, at a cost of approximately $8 million.
With numerous investment and financing choices, and weary investors choosing between yet another rash of airport privatizations, perhaps the time is ripe to look elsewhere ? perhaps REITs are the answer.
But as airports around the world struggle to find the necessary investment, the US seems to be somewhat better off. The US Congress is completing the second of two bills which will increase funding in US airports and ATC by an extra $40 billion over the next three years. The bill, in the Aviation Investment and Reform Act for the 21st Century, will allocate cash to each airport according to a formula based on traffic. Donald Carty, chief executive of American Airlines said at the announcement: ?No one can say the problem is a lack of funding? ? there's a sentence the rest of the world would like to be able to say.
To date the real estate investment trust (REIT) has only been used to partially fund airports. There are advantages to using a REIT as a financing vehicle. The first is that a REIT can finance the entire amount of real estate, which is securitized, while debt only finances a proportion of the assets. In addition, financing payments are only made when the cash comes home ? so if you have no income, you don't pay off the financing. This cuts out the interest charges which are inevitable with debt financing.
Not only that, but you are looking at a whole new investor base.
?The benefit of using a REIT for this would be to access a different market for capital,? explains Bruce Kayle, a tax lawyer at Milbank, Tweed, in New York. ?It is entirely possible that someone could do it. Financial institutions that see the opportunity may want to do it. It is as much a pricing issue as anything else. Selling interests in a REIT would involve a different investor class than you would otherwise go to for an airport.?
REITs in the US benefit from the tax laws, which allow them to deduct tax depreciation when calculating their income ? which airports are not able to do. No tax is payable at the REIT level ? the only tax liability is for the share or unit holders when they receive their dividends. And REITs are a particular favourite with the US capital markets.
?REITs are accepted by the capital markets as they look, and act like a corporation,? says David Right of Hunton & Williams. ?In a way they are better, as the markets know that they act in the interests of the investors. The management structure is accepted by lenders.?
However, there are drawbacks. A REIT must make the vast majority of its income from rental. REITs are required to be passive, and may not operate an airport; they can only own it. In the US, from January 1 2001, however, the law is changing to allow REITs a little more flexibility, and from then subsidiaries of REITs will be able to operate from the real estate, although income tax will apply.
Kayle agrees that the tax and ownership status could involve some complicated work. Although there are two options for potential airport owners: ?The REIT either would have to be a mere lender to the operator of the airport, or could own the airport, provided that it leased the airport out under a triple net lease.?
One of the more problematic issues for using REITs ? and one of the reasons it has not yet been used ? is the fact that it is a US structure, based on US tax law, and US airports are publicly owned. However, other countries have implemented similar laws, including Japan, the UK, and several other western European countries.
A source at a US company specializing in REITs explains: ?There are different challenges in different countries, the tax laws for example. Can you restructure the investment and repatriate the capital without tax leakage? I don't know of any hurdles specific to airports, but you would have to lease the real estate to an operator, and you would have to bifurcate owning and operating, which may be an additional issue under US REIT laws, but it does depend on the country.?
AMB is the biggest owner of airport real estate in the US and came close to financing an entire airport through REITs. What stopped it was not the impracticality of using the vehicle, but the fact that it changed its strategy and decided it wanted parts of airports, not whole ones (AMB is nevertheless the seoond largest REIT in the US). And according to Blake Baird, head of investment at San Francisco-based AMB: ?The structure could finance a wide variety of airport buildings.?
He adds that some REITs are considering financing a whole airport infrastructure, but it has happened yet for a variety of reasons. ?Airports need a whole lot of capital. Our company has $4 billion in assets. To own a whole airport would take up too large a percentage of our assets in one facility, and it would take up too much capital. The infrastructure costs on an airport could go into billions.?
AMB has been looking to buy property outside the US for 18 months but, ominously, ?we haven't found the right tax structure? adds Baird. If the country's tax laws are compatible with the vehicle, however, one option would be to use a hybrid structure, where part of the buildings of the airport are owned by a REIT, while other forms of financing continue to be used in the project.
Kayle agrees: ?It may be that you could do one part of it through a REIT, if the whole thing turns out to be more than the market can absorb.? But whether it would be worth the heavy transaction and documentation costs associated with breaking the mould on a financing structure is unclear. That road may be better trodden once someone has already used a REIT to finance an airport for the first time. And when will that happen?
?I would not expect to see REIT finance happening in the near term for airports,? says Baird. ?Airports are more likely to be funded through collaberation, or perhaps through a consortium.? Kayle is slightly more positive. ?It's an economic question,? he says. ?It would depend on the pricing and the transaction costs. At the end of the day, it's a market call.?
A privatization alternative?
But with the spate of privatizations coming up in western Europe, it may well be an advantageous time to be looking at different structures, and different sources of capital and investors.
A consortium including Flughafen Frankfurt-Main has recently won the Peruvian government's concession for operating and expanding Lima's Jorge Chavez International Airport, as part of its stalled privatization programme. The consortium also comprised Bechtel Enterprises, which, like Frankfurt holds a 42.75% stake, and Peru's largest construction firm Cosapi, which owns the remaining 14.5%. The consortium must invest at least $12 million each year in the first two years, and a second runway has to be built within 11 years. The Peruvian government was hoping for investment of $100 million in the first three years, and $550 million within 10. Frankfurt beat off competition from three other consortia, led by Vancouver Airport, Vienna Airport and Spain's Aeropuertos.
Robert Payne, head of international press for Flughafen Frankfurt-Main, is reticent over the details of the group's financing plans, but admits he is hopeful of the outcome of Frankfurt's own privatization to help raise capital for the project. ?We are planning an IPO for the summer of 2001, which is, obviously, dependent on market conditions. But of the money raised through our partial privatization, some will go to finance expansion at Frankfurt itself, and some will be used for our global expansion ? part of which includes Peru.?
Frankfurt's IPO may be blown slightly off course by German airline Lufthansa's recent announcement that it is to develop a second hub at Munich. Although Frankfurt's expansion will go ahead as planned, investors may be concerned by the news.
They may also become tired of the number of share offerings and IPOs on the market. Grupo Aeroportuario del Sureste, the Mexican airport operator, is planning to raise $400 million from its IPO on the New York Stock Exchange. And Swiss operator Unique Zurich issued a secondary offering of 1.2 million existing shares in November, led by CSFB. Pricing for the shares opened at Sfr250 ($141) and closed at Sfr282. The offering was successful, despite market concerns that the next wave of privatizations may cause investors to become wary of the sector.
Privatizations, or partial privatizations planned for this year include Amsterdam Schiphol Airport, Zurich, Brussels and Vienna. A recent report from Standard & Poor's warns of potential problems ahead for these airports, as they try to satisfy their new shareholders, increase traffic by offering discounts to airlines, and raise finance for new airport projects. Both London Luton and Aer Rianta have fallen foul of their incumbent airlines by cutting back aeronautical charges, only to raise them significantly once the carriers are well-established. Although airports have a relatively stable income, it is likely that the newly privatized European majors will start to leverage up their balance sheet, because of regulatory price setting requirements or concern over shareholder dividends.
But some do not seem to be so worried about their financing commitments, or leverage. Frankfurt's Payne says: ?Raising money is not a problem for us. The banks are knocking at the door.?
Other airports still in the stages of privatization cannot afford to be quite so bullish. According to local press reports, Pietersburg International Airport in South Africa, privatized just six months ago ? is on the verge of collapse. The government awarded the 50-year concession for the airport to a Malaysian company, Onstream Services, despite a warning from adviser HSBC that the company was not sufficiently financially transparent. Onstream had pledged an initial injection of R5 million ($563 million) but has been unable to source the required capital for the airport, which has run at a loss for over four years.
Let that be a warning to the next spate of African privatizations, which include Maputo Airport in Mozambique. Bidding for the airport has begun, for a 12-year concession for operating and modernising. The airport is estimated to need some $25 million, and in exchange the winning bidder will be able to manage and operate it. An announcement is expected in the first half of next year.
Any bidders may do well to look at the example of Baku Airport in Azerbaijan, which has just secured funding from the UK's ECGD. The ECA is to offer $30 million to build a new cargo terminal, with a 12-year term and 7.4% annual interest. The loan is expected to be repaid within 10 years. The airport has also attracted interest from KfW which is considering offering finance to rebuild the runway, at a cost of approximately $8 million.
With numerous investment and financing choices, and weary investors choosing between yet another rash of airport privatizations, perhaps the time is ripe to look elsewhere ? perhaps REITs are the answer.
But as airports around the world struggle to find the necessary investment, the US seems to be somewhat better off. The US Congress is completing the second of two bills which will increase funding in US airports and ATC by an extra $40 billion over the next three years. The bill, in the Aviation Investment and Reform Act for the 21st Century, will allocate cash to each airport according to a formula based on traffic. Donald Carty, chief executive of American Airlines said at the announcement: ?No one can say the problem is a lack of funding? ? there's a sentence the rest of the world would like to be able to say.
Request a Demo
Interested in IJGlobal? Request a demo to discuss a trial with a member of our team. Talk to the team to explore the value of our asset and transaction databases, our market-leading news, league tables and much more.