Data center REITs operate crucial data infrastructure. They own and manage facilities that customers use to house servers and networking equipment to store and access data. With data usage growing, demand for these facilities continues to expand.
Here's a closer look at data center REITs and why investors might want to consider the sector.
Understanding data center REITs
A data center is a specially designed facility consisting of the building shell; electrical systems; heating, ventilation and air conditioning (HVAC) and mechanical systems; and other commercial space. Data centers feature highly secure and redundant equipment. They aim to provide customers with uninterrupted access to their data at any time.
Like most other real estate investment trusts (REITs), data center REITs rent space in their facilities to tenants. They typically rent space to multiple customers (e.g., co-location) but can rent the entire facility to one tenant (e.g., enterprise or hyperscale). The tenants use this space to house their networking equipment and servers, allowing them to process and store data.
In addition to renting space, data center REITs provide several other specialized services to their customers, including highly reliable power, a regulated temperature, and physical building security. Data center REITs also provide interconnection services to their clients, meaning a physical network connection between two parties.
Advantages of investing in data center REITs
Data center REITs allow investors to benefit from the growth in data usage. According to IDC, data usage is on track to grow at a 24% compound annual rate through 2025. That should drive the need for additional infrastructure to transmit and store data, including more data center capacity.
Another benefit of data center REITs is that they tend to be relatively recession-proof. That's because most tenants sign long-term contracts for space in a data center, allowing data center REITs to generate recurring revenue.
Risks of investing in data center REITs
- Interest rate risk: Rising interest rates affect all REITs because REITs tend to borrow a lot of money to expand. As rates rise, borrowing costs can increase. In addition, rising rates make lower-risk, yield-focused investments such as bonds more attractive. That often weighs on REIT stock prices to push up their dividend yields and compensate investors for their higher risk.
- Oversupply risk: Data center operators often build new capacity on speculation. If they build too many data centers, the surplus can affect occupancy levels and rental rates.
- Environmental risks: Data centers use a significant amount of energy and water to keep servers and networking equipment running and cool. Because of that, they face environmental risks from climate change, storms, and droughts that can affect a data center's ability to deliver 100% uptime.
Three data center REITs to consider in 2022
According to the National Association of Real Estate Investment Trusts (NAREIT), as of March 2022, only three REITs exist that are primarily focused on owning and operating data centers. Here's a closer look at this trio:
|Data Center REIT||Ticker||Market Cap||Description|
|CyrusOne||(NASDAQ:CONE)||$11.69 billion||A data center REIT with 50 data centers around the world.|
|Digital Realty||(NYSE:DLR)||$39.52 billion||A data center REIT with 285 facilities in 50 metros on six continents.|
|Equinix||(NASDAQ:EQIX)||$66.49 billion||A data center REIT with more than 240 data centers in more than 66 metros in 27 countries.|
CyrusOne specializes in providing data center services to the world's largest companies. It offers a flexible data center solution, Massively Modular, that allows it to expand as customers grow. CyrusOne can build out new data halls in only 12 to 16 weeks to quickly meet a client's need for more storage capacity.
The company has steadily expanded over the years. It has added new U.S. markets to support a national footprint and expanded into Europe and Latin America. These investments have enabled the data center REIT to increase its revenue and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) at a 20% compound annual rate since 2015.
CyrusOne expects to continue growing in the coming years. The company anticipates it will be able to develop new data centers as customers need more space, allowing it to deliver healthy revenue and earnings growth.
Digital Realty is one of the largest data center operators in the world. In addition to renting space in its facilities to companies to store their networking and storage equipment, Digital Realty also leases entire data center shells to other operators, including fellow data center REIT Equinix.
Digital Realty has delivered excellent results for investors over the years. It has spent billions of dollars buying data centers to complement its organic growth. Those two growth drivers helped the data center REIT expand its core funds from operations (FFO) at an 11% compound annual growth rate since 2005. That helped support 10% compound annual dividend growth during that time.
The REIT has a strong financial profile, including an investment-grade credit rating and conservative dividend payout ratio. Those features give it the flexibility to continue growing in the future.
Equinix is one of the world's largest digital infrastructure companies. It has more than 10,000 customers and 419,000 total interconnections on its systems.
Equinix also has an excellent growth track record. As of 2021's second quarter, the data center REIT had increased its revenue in 74 straight quarters, which the company claims is the longest track record of any company in the S&P 500. One factor driving its steady growth is its high recurring revenue business model. On top of that, the REIT has a knack for steadily expanding its operations through ground-up developments and acquisitions. That's allowed it to create significant shareholder value. It delivered the third-best performance in the REIT sector over the past decade, with an almost 1,000% total return.
Like Digital Realty, Equinix has an excellent financial profile. That gives it ample financial flexibility to continue expanding its data center portfolio.
Related investing topics
Data center REITs have benefited from the explosive growth in data usage over the years. This catalyst has allowed these REITs to expand their portfolios, driving fast-paced revenue, earnings, and dividend growth. Those upward trends aren't showing any signs of stopping, given the current projections for data growth in the coming years. Consequently, investors should take a closer look at data center REITs.