Data Centers: It's All About Hyperscale

Feb. 22, 2018 9:16 AM ETAAPL, AMZN, CONE, AMT, DLR, EQIX, GOOG, IYR, MSFT, ORCL, QTS, SPY, VNQ36 Comments

Summary

  • Data Centers were the standouts of the REIT sector in 2017, returning more than 25%. Riding the big-data wave, the sector continues to be the growth engine of the industry.
  • The growth of the hyperscale public cloud providers, including Amazon, Google, and Microsoft, continues to be a long-term competitive risk. For now, they have a symbiotic relationship with these REITs.
  • The boom in demand for data center space has been met by an equal boom in construction activity. AFFO growth has slowed as competition has heated up significantly since 2014.
  • 4Q17 earnings were generally in line with expectations but guidance was conservative. Leasing activity continues to be light and choppy but pricing has remained firm and EBITDA margins have improved.
  • In a reflection of the shifting landscape, QTS announced a strategic shift to focus exclusively on wholesale hyperscale and hybrid co-location, divesting from its retail cloud and managed service business.

REIT Rankings: Data Centers

In our REIT Rankings series, we introduce readers to one of the fifteen REIT sectors. We rank REITs within the sectors based on both common and unique valuation metrics, presenting investors with numerous options that fit their own investing style and risk/return objectives.

data center REITs

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Data Center Sector Overview

Data Center REITs comprise roughly 9% of the REIT Indexes (VNQ and IYR). Within our Hoya Capital Data Center index, we track the five data center REITs within the sector, which account for roughly $75 billion in market value: CoreSite (COR), Digital Realty (DLR), Equinix (EQIX), CyrusOne (CONE) and QTS Realty (QTS).

data center REITs

We note the strategic focus of each of the five REITs above. "Quality" is determined by the average value per square foot of the underlying data center portfolio. The value of each data center is largely a function of its position along the internet backbone, the physical fiber optic network that links every connected-device across the world. Properties within the backbone are able to provide higher-value network-based "co-location" and interconnectivity services, which command higher rent-per-MW and generally have higher barriers to entry. Properties on the periphery typically provide more ubiquitous enterprise-based services, including storage and cloud-based software applications, and primarily rent these facilities to wholesale customers who pay lower per-SF rent.

Equinix has the highest "quality" portfolio of network-dense assets (roughly 65%) followed by Digital Realty and CoreSite (each roughly 30%). CyrusOne and QTS focus primarily on lower-valued enterprise assets. We also note that Digital Realty and Equinix have a global data center platform while the other three REITs are primarily US-focused. Finally, we note that unlike the other

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