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Data-Center REITs: Financials Set Them Apart

By Motley Fool Staff - Oct 1, 2017 at 5:15AM

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REITs’ core advantages almost always stem from their balance sheets.

Data-center REITs are only as strong as their balance sheets and their ability to finance assets at an attractive price. In many ways, like banks, the data-center REITs that have the financial scale and the ability to borrow money at a lower cost of capital have a huge advantage over their peers.

In this episode of Industry Focus: Financials, join Michael Douglass and Jordan Wathen as they discuss why one of the surest competitive advantages for any REIT is scale, along with the ability to secure financing for the assets they buy and lease to their clients.

A full transcript follows the video.

This video was recorded on Sept. 25, 2017.

Michael Douglass: Let's talk a little bit about thinking about REITs as a whole, and these data-center REITs in particular. If you're thinking about investing in this space, what sets one apart from another?

Jordan Wathen: So one of the biggest differentiators is obviously scale. And there's multiple ways to measure scale. The first way is financial scale. You have to be pretty big to issue a bond. If you're a REIT who wants to finance real estate with a bond issuance, you need to be able to issue $200 million or $300 million at a time. That's a whole lot of money. You can't just do that overnight. You can't just do that as an upstart. And I guess there's also, to an extent, a geographical component. If you as a customer of a data-center REIT can go to one data-center REIT and say, "Look, I need to be in 50 countries tomorrow," and that data-center REIT can do that for you because it already has the space and all these different data centers around the world, that's an advantage, too, I'd say.

Douglass: Yeah. I think the other big advantage is one across REITs. Real estate investment trusts as a whole are required by law to pay out almost all of their earnings as dividends. So as a result, when they're trying to raise money and take money and spend it on something, like, for example, buying a new warehouse, or in this case, a new data center, they have to take out debt to do so, or they have to issue equity. And if they're going to take out debt, one of the big things is that they need to be able to get that debt at a relatively low interest rate. If you are, let's say it costs you, I'm making up this number, $10 million a year in interest to have a mortgage on a new data center that you just purchased, you can't be leasing it out at less than that. You're not going to make a dollar if you do that. So you have to be leasing out at more than that. So, low cost of borrowing is important, and that's why size really matters. Frankly, if you're going to lend to a business that has a market cap of $2 billion versus one that has a market cap of $10 billion, you're going to prefer the $10 billion business because it's just bigger, and that probably means it's more stable. All other things being equal, of course. And the other piece of that is a strong balance sheet. If you have a REIT that is relatively underleveraged, it's going to be more able to take out that kind of debt, and therefore get that debt at a lower interest rate so that it can compete more effectively for customers. 

Wathen: In some way, it's almost like looking at banks. The bank with the lowest-cost deposits wins, generally speaking. They don't have to take on more risk, they don't have to do crazy things, they just have that financing advantage that's so huge. So you can make a lot of mistakes and still do just fine.

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