News
Private credit lenders look to architecture, engineering for steady borrowers
While software and business services remain private credit favorites and AI hogs headlines, some lenders are leaning into more traditional infrastructure. Capital-hungry architecture, engineering and construction (AEC) platforms have caught the attention of private credit lenders, which appreciate the investment area’s uncorrelated nature and the reliability of borrowers in the space.
Although less groundbreaking than new data centers, private credit lenders are seeing the merits of the straightforward business of essential long-term infrastructure projects, like buildings, hospitals, water lines and transportation systems. Spreads and maturities on these loans are not unlike other private credit financings, market participants say.
Private credit lenders are also attracted to the non-discretionary nature of infrastructure projects and the support they receive from government spending initiatives, leading to higher stability for both public and private investments in the related sectors.
“The historical under-investment in infrastructure across the US is creating a dynamic where additional dollars are flowing into particular regions and municipalities, creating pockets of local government investment that can be very interesting from an investment perspective,” said Garrett Stephen, senior managing director and co-head of origination at First Eagle Alternative Credit, in an interview with LCD.
“There are various spending bills that are bolstering overall spending at a local, state, and federal basis,” Stephen said.
The American Society of Civil Engineers’ latest report on the state of US infrastructure said that the country’s funding gap in the space “grows as existing infrastructure systems continue to age and demands on those systems increase, ”highlighting the need to reinforce aging infrastructure along with the growing need to support community expansions with new projects.
Even with the federal government’s 2021 Infrastructure Investment and Jobs Act, the report estimates a funding gap of $3.7 trillion if all 18 of its infrastructure categories are to reach what it considers to be a state of ‘good repair.’ The engineering society’s estimates could exceed actual funded projects.
But even a fraction of this figure represents a massive opportunity for direct lenders to participate in funding the infrastructure boom.
The business models are also less susceptible to AI disruption, which has some participants raising alarm over the private credit industry’s many tech and software-focused bets in recent years.
“Bridge” loans
Lenders say that the AEC space is fragmented, with relatively few “buy-and-build” strategies that private credit lenders are accustomed to in the popular sectors of sponsor finance in recent years. High-growth regions like Texas, Arizona and Florida are seeing a surge of AEC activity that is being driven by rapid urbanization, population growth and infrastructure demand, said Max Mahan, director in US direct lending at Sound Point Capital in an interview with LCD. That being said, multiple lenders also mentioned that aging infrastructure, including in regions like the US Northeast, also presents compelling growth opportunities in its own right.
“Infrastructure spending more broadly is creating increased investment in the space because many of these municipalities have outdated infrastructure, buildings and schools, for example, that have been there for sometimes over 70 years, that are well overdue for some type of upgrade,” said First Eagle’s Stephen.
Another quirk of this sector has to do with the funding flow: unlike a typical business services platform working with corporate clients, infrastructure platforms often work closely with the state and local governments that fund most infrastructure developments across the country.
“Our underwriting process is largely shaped by state and local funding dynamics in jurisdictions where the company operates. These governments own the vast majority of public infrastructure and fund most of its upkeep — so understanding the local capital flow is essential to our approach,” said Sound Point’s Mahan.
These AEC platforms often begin with companies that focus on narrower geographical areas with specific strategies that involve constructing new neighborhoods or maintaining infrastructure for existing ones. These initial focuses can include anything from civil engineering, transportation infrastructure, water system sand utilities, structural engineering, land surveying and interior design.
These platforms are then typically expanded with bolt-on acquisitions to either increase the scale of a company focused on one of these niches, such as a large architecture-focused firm, or with the aim of widening the company’s service offering to encompass a broader and more diversified range of these specialties. Mahan said that Sound Point, for example, has prioritized platforms that integrate what it considers to be high-impact subsectors like transportation, water systems, and sustainable infrastructure.
An example is The HFW Companies, an AEC platform backed by VSS Capital Partners that houses 10 architecture and engineering companies under its umbrella following its founding in 2020.
The construction sector can be vulnerable to commodity risk regarding the raw materials used in the industry, particularly in light of the recent tariff concerns. But market participants say that not all AEC companies are exposed. For example, government involvement in many of these infrastructure projects often lessens tariff exposure due to the distinct calculations that go into the government procurement processes.
“For many projects that involve government funds, the procurement process often prioritizes local sourcing, so they buy fewer inputs from abroad which tends to make these projects somewhat more insulated from tariffs,” said Sai Parepally, Vice President at VSS, in an interview with LCD.
Furthermore, lenders we spoke to highlighted personnel salaries as the highest business costs for these platforms, describing architecture and engineering as human capital businesses that rely on the expertise of the highly trained professionals involved. Investors said that they place a premium on leadership strength, operational discipline and deep technical talent when underwriting these platforms.
“When you’re investing in these businesses, you’re really investing in the talent. A certain architect, for example, might be well-known in their particular industry or in a certain geography, so it is really important to retain and incentivize those particular employees through their contracts because at the end of the day they’re mission-critical to the underlying business,” said First Eagle’s Stephen.
Some recent deals in the space include:
· Lathan Architects, which received financing from First Eagle for an add-on acquisition of two other architecture firms in April
· Apollo’s acquisition of PowerGrid Services, supported by a $950 million debt package led by Brookfield Credit, Blackstone Credit and JPMorgan direct lending
· The HFW Companies bolt-on acquisition of Southwest Engineers in May, supported by VSS Capital Partners
· Electric Power Engineers recapitalization in March, financed by Audax Private Debt
Labor constraints
Lenders also noted the broader shortage of skilled trade workers like architects and engineers, highlighting that the importance of retaining top talent is even greater, considering the labor pool constraints in those areas. However, if employee retention is done well, these platforms can put in place an enhanced moat around their business by capturing some of the leading talent in an industry with a shortage of workers.
That shortage of skilled trade workers was the focus of an executive order signed by President Trump earlier this year. The order aims to bolster apprenticeship programs and shift “federal investments in workforce development to align with our country’s reindustrialization needs and equip American workers to fill the growing demand for skilled trades and other occupations.”
While details on how the shift will be funded are not clear, a Reuters report from April says that the goal is to redirect “funds away from ineffective programs,” according to a person familiar with the plans. It’s hard to say what the lasting power of an executive order like this will be, but the plethora of secular tailwinds supporting the sector suggests that it’ll continue to grow across administrations.