Data is king these days. Just think about how much time you spend on the Internet and using apps on your phone.
In 2020, 64.2 zettabytes of data was created or replicated, according to IDC, a technology information firm. That's more than 6 trillion gigabytes. A zettabyte equals 1,000 to the seventh power of bytes.
And IDC predicted last year that global data creation and replication will enjoy a compound annual growth rate of 23% over the 2020-2025 period.
That’s good news for data-center real estate investment trusts. And they can use it. Data center REITS have generated a negative return of 21.4% so far this year through June 9. To be sure, they produced a positive annualized compound return of 9.1% over the past five years.
“We think it's time for investors to rotate back into data centers,” Wells Fargo analysts wrote in a commentary. “The demand environment, driven by hyperscalers [such as Google and Amazon’s AWS], is only improving, with record leasing expected in 2022.”
One important positive: “we are seeing hyperscalers tilt toward leasing versus self-building, which has dramatically expanded the addressable market,” the analysts said. “New lease pricing is up 5%-10% year to date while supply conditions continue to tighten.”
Rent Escalators
In addition, “operators are starting to address escalator rates [for rent], with a potential move toward consumer-price-index-linked escalators.” That would certainly be helpful for the REITs, as the CPI soared 8.6% for the 12 months through May, a 40-year high.
“We think the recent demand strength … will continue, at least in the near-term,” the analysts said.
“We project more than 70% of requirements this year are being leased [as opposed to owned], versus a historic 40-50%.... We think annual hyperscale capacity requirements of about 2 gigawatts per year today will scale to 4 gigawatts in the next five years.”
Meanwhile, supply is constrained, benefiting existing players, the analysts said. “In certain markets, like Northern Virginia…, it can take two to three years to procure power for new sites. The supply of available land has also shrunk considerably.”
Data centers can represent a defensive investment, the analysts said. That’s because of record demand, improved pricing and strong cash flow.
The analysts prefer data-center REITs over cellphone tower REITs, because the former trade at a sizable discount, despite similar adjusted funds from operations and share-price trajectories.
Digital Realty Trust (DLR) remains the analysts’ top pick. Both it and Equinix (EQIX) “trade at favorable relative valuations, about 2x below trailing five-year averages,” they said.
“We expect DLR's shareholder returns to converge closer to EQIX's in the coming years, which should shrink its 2x-3x discount to EQIX.” Further, “we believe DLR's bookings could accelerate meaningfully in the coming quarters based on the demand backdrop we're seeing.”
The analysts also recommend record management services provider Iron Mountain (IRM) as a “niche data-center play.”
