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3 Companies Share Their Formulas for Success

If you had to guess, which company below do you think has outperformed the S&P 500 during the past year? All REITs are sensitive to moves in interest rates, and it is the rare bird that can continue to fly high in the face of higher interest rate headwinds.

Keep in mind that REIT investors are also willing to pay a premium for a management team they believe can grow property portfolios more profitably than industry peers.

Here are the contestants
Digital Realty provides the buildings and infrastructure required for data centers. American Tower (NYSE: AMT  )  focuses on cell towers. Extra Space Storage (NYSE: EXR  )  is one of four REITs that make up the self-storage sector. One of these companies has found the secret sauce for success.

Executives representing these three entirely different specialty REIT sectors shared how their companies are positioned for future growth during the ISI Real Estate Conference held on Oct. 3, 2013. I felt investors would benefit from the highlights, challenges, and opportunities each company revealed during a 45-minute panel discussion.

Data centers, collocation, and the cloud
Digital Realty has 127 facilities located in the U.S., Europe, Asia, and Australia totaling over 23 million square feet. Digital's market cap of $6.7 billion is several times larger than any competitor. This REIT sector benefits from the growth in big data across multiple sectors, such as information technology, e-commerce, health care, and financials.

CEO Mike Foust emphasized these points:

  • Corporate enterprise IT outsourcing is just in the early stages.
  • Proprietary POD 3.0 Architecture provides customers "a building within a building" with fully dedicated power and cooling -- a stand-alone solution.
  • The recent $369 million joint venture with Prudential Financial (NYSE: PRU  ) validates data centers as an asset class for institutional investors.
  • Leasing activity has been soft in Europe and in the Silicon Valley, but it's picking up in the Northern Virginia market.

Digital Realty needs to be viewed in terms of scale. Being the big dog in its sector gives it advantages in procurement from critical suppliers. However, companies with a global footprint interested in partnering with Digital take a long time to sign on the dotted line.  This reduces earnings visibility on a quarterly basis, and that is currently reflected in the stock price.

Can you hear me now?
American Tower now owns 61,000 cell towers worldwide -- with 26,000 in the U.S. Its market cap of $28.9 billion weighs in as the second largest U.S. REIT behind $46.9 billion mall landlord Simon Properties. 

CFO Tom Bartlett made these points:

  • 4G/LTE "is in the early innings" -- less than 10% adoption currently.
  • Leases are highly concentrated in four top customers: wireless carriers.
  • Expects to see double digit revenue growth, with half coming from lease escalators.
  • CPI increases internationally average 200 to 300 basis points higher than the U.S.
  • Recently closed on the $4.8 billion dollar acquisition of Global Tower Partners cell tower assets, which in turn means a focus on balancing out capital structure.

American Tower is a communication real estate juggernaut; however, there may be bumps in the road in the short term. My sense is this REIT is in the moat-building business. It's challenging competitors to put more skin in the game or be left behind.

Technology helps self-storage REITs to prosper
Extra Space Storage with a $5 billion market cap is the second largest self-storage REIT behind $24 billion industry giant Public Storage. Extra Space operates 900 self storage facilities in 38 states containing over 59 million square feet of space. 

CEO Spencer Kirk highlighted these business drivers:

  • There is virtually no new supply being built in the U.S.
  • The top 10 companies, including all four REITs, operate less than 10% of the 54,000 self storage facilities -- plenty of opportunity for growth.
  • The company has 44 people focused on Internet strategy and spends $1 million per month advertising with Google, which in turn drives a disproportionate share of customers to Extra Space compared to private operators.
  • During 2013, 25% of customers used a mobile device while searching for storage, and management sees this increasing to over 50% in 2014.
  • Having the sophistication to optimize SEO results is driving record occupancies.

Extra Space has an ace up its sleeve -- 50% of the properties it operates are in joint ventures or under third-party management. Mr. Kirk made it clear that there's a bidding war under way for properties in major U.S. markets. However, when property owners flying the Extra Space flag decide to sell, they typically make one phone call. These off-market acquisitions are an ingredient of the secret sauce.

^SPX Chart

Investor takeaway
Do you have any Extra Space in your portfolio? Congratulations -- you picked a winner! The other specialty REITs are in sectors that have excellent growth prospects as well. Digital Realty is currently paying a dividend yielding over 5.8% -- value investors may want to take a long look at this leading data center REIT. American Tower remains on my watchlist for now.

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