Data Center REITs

Data centers are booming, and investors are taking notice. Real estate investment trusts that focus on data centers have seen strong interest from investors and acquirers. In 2021, one such REIT – CoreSite Realty Trust – was snapped up by American Tower, the owner of cellular communications towers. And it’s possible the sector will see more merger and acquisition activity in the future. While the players in this growing property sector haven’t amassed the same name recognition as retail giant Simon Property Group or warehouse owner Prologis, data center REITs have been coming on strong.

 

By some reckonings, this might be the most important corner of the REIT market. After all, without data centers and their storage capacity, good luck completing such routine tasks such as ordering from Amazon, binge-watching Netflix or sending money via PayPal or Venmo. Data centers serve an important but little-noticed function in the digital economy. Publicly traded REITs control just a fraction of the data center market – Hoya Capital says data center REITs own about 600 data centers, a number that represents 30% of investment-grade data centers in the U.S. and about 20% of global capacity

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What is a Data Center?

Data centers exist to accomplish a very specific task – they host servers, storage devices, switches, routers and fiber optic transmission equipment used by tech companies, communications providers and consumer brands to serve their end users. To compare data centers to one better-known property type, think of a data center as an office building built for computers rather than for workers Or think of it as a warehouse that stores servers rather than goods destined for consumers. Like warehouses, data centers are designed to be highly functional but not visually appealing. These structures are utilitarian. While they won’t win any architecture awards, data centers are crucial to the global economy. Data center landlords must offer a reliable supply of power and water, proximity to connection points such as fiber optic networks, and high-end security. So far, these centers are concentrated in a handful of geographic areas, including Northern Virginia, Dallas-Fort Worth and Silicon Valley. However, a global building spree is under way.

Why Data Center REITs are Attractive

Investors expect demand for data centers to only increase in the coming years and decades as Silicon Valley churns out more and more data-hogging devices. One example: autonomous vehicles. If self-driving cars become a reality, data usage would soar. The situation is similar for artificial intelligence – more AI means more data and, ultimately, more customers for data centers. Meanwhile, data center REITs performed well through the coronavirus pandemic. Many traditional REIT sectors, such as retail, office and hotel-focused REITs, struggled with lockdowns and disruptions to normal patterns of work and travel. But demand for digital services only increased. Consumers in the U.S. and around the world shifted their focus away from in-person shopping to ecommerce. Remote work and schooling via Zoom and other platforms replaced in-person activities. Streaming movies and music elbowed out in-person movies and concerts. All of those trends created a massive tailwind for data centers.

Investing in a Data Center REIT Index

The population of data center REITs remains small enough that there’s no pure-play index that invests solely in data center REITs. However, a couple of exchange-traded funds come close. If you want to play the data center market, one option is the Pacer Benchmark Data & Infrastructure Real Estate SCTR Exchange Traded Fund (Nasdaq: SRVR). This ETF’s largest holding is Equinix (Nasdaq: EQIX), the largest of the data center REITs. However, its next six largest holdings are not pure data center owners. Instead, the portfolio is dominated by names such as Crown Castle Holdings (NYSE: CCI), American Tower (NYSE: AMT) and SBA Communications (Nasdaq: SBAC). All three of those REITs are primarily owners of data communications towers.

Another option is the Global X Data Center REITs & Digital Infrastructure Exchange Traded Fund (Nasdaq: VPN). However, the fund’s largest holdings aren’t data center REITs but owners of communications towers. Its two largest holdings as of late January were Crown Castle Holdings and American Tower. Tower operator SBA Communications was its fifth-largest holding. A third option, the iShares Cohen & Steers REIT ETF (NYSE: ICF) has Equinix as its largest holding, followed by other REITs, including American Tower and Prologis.

 Investing in Data Center REITs

 

If you’re looking for an easy, direct and high-liquidity way to invest in data centers, several publicly traded real estate investment trusts fit the bill. These are the largest U.S.-based data center REITs by market capitalization as of Jan. 31, 2022:

 

  • Equinix (Nasdaq: EQIX) had a market cap of $64 billion and a yield of 1.62%. The company is headquartered in Redwood City, California. As of Dec. 31, 2020, Equinix owned 224 data center buildings worldwide.
  • Digital Realty Trust (NYSE: DLR) had a market cap of $42 billion as of Jan. 31, 2022, and a yield of 3.19%. The company is based in Austin, Texas. As of Sept. 30, 2021, Digital Realty Trust owned 282 data center buildings encompassing 35 million rentable square feet. It reported an occupancy rate of 84%.
  • Iron Mountain (NYSE: IRM) had a market cap of $13 billion and a yield of 5.5%. This Boston-based company isn’t solely a data center operator. It also stores paper records and offers shredding services.
  • CyrusOne (Nasdaq: CONE) had a market cap of $12 billion and a yield of 2.32%. The company is headquartered in Dallas.
  • QTS Realty Trust (NYSE: QTS) had a market cap of $6 billion and a yield of 2.56% before it was taken private by Blackstone Group in January 2022. The REIT is headquartered in Overland Park, Kansas. Another publicly traded REIT, CoreSite Realty, was acquired in 2021 by American Tower.

Data Center REITs and Dividends

Data centers REITs blend a bet on technology, a high-flying sector, with an investment in REITs, an income-producing investment. By law, REITs aren’t required to pay corporate income taxes so long as they distribute 90% of their profits in the form of dividends. This requirement makes REITs a favorite of yield-seeking investors. However, dividends in the data center niche tend not to be especially high. Among the four pure-play data center REITs above, yields range from 1.62% to 3.19%. The one outlier pays 5.5%, but it’s not a pure-play data center landlord. 

 REITS and Interest Rate Risk

The Federal Reserve has signaled that it expects to begin raising interest rates as early as March 2022. The Fed has telegraphed to investors that it plans to raise rates three times in 2022. Rising interest rates commonly are bad news for REIT investors. In fact, interest rates might be the single biggest risk factor for REIT share prices. That’s because REITs are income-based assets, and income investors seek out a higher return than is available from such risk-free investments as Treasury securities. When risk-free yields rise – as signaled by the 10-year Treasury, the benchmark for this metric -- REIT yields tend to rise accordingly. Because yield and share price are inversely correlated, rising yields generally portend lower share prices. Of course, such rules of thumb are imperfect. And it’s possible that investors in data center REITs might conclude that the sector’s growth potential outweighs the usual concerns about interest rates. However, it’s worth keeping in mind that a rising interest rate climate often leads to soft returns for REITs.

Conclusion

Any investment carries risk, of course, but the digitization of the world economy no longer is the future – it’s the present. It’s quite possible that the easy profits on data center REITs already have happened, and the going will get tougher ahead. Even so, nearly everyone paying attention to the data center space expects increasing demand. While data center REITs pay modest dividends compared to other types of REITs, there’s still an opportunity for investors to realize future returns by making a bet on a sector that’s only expected to grow in the coming decades. 

POSTED BY

ChrisRising

CHRIS RISING

Chris Rising manages the day-to-day business activities of Rising, while also serving on its Investment Committee.

He received his J.D. Law, Real Estate from Loyola Law School and his B.A. in History and Political Science from Duke University.