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Data Center REITs On Sale Despite Record Leasing

Feb. 06, 2019 10:38 AM ETCONE, AMT, DLR, EQIX, QTS, DBRG, VNQ, AMZN, GOOGL, IBM, JLL, MSFT, IYR4 Comments
Chilton REIT Team profile picture
Chilton REIT Team
1.74K Followers

Summary

  • 2018 was the first time since 2012 that data center REITs underperformed the MSCI US REIT Index (Bloomberg: RMS G) and the S&P 500 (Bloomberg: SPX).
  • Cloud revenue growth decelerated at Microsoft and Amazon in 2018, so many investors assume data center leasing also weakened.
  • In fact, net absorption in the largest US markets actually set a new record in 2018, up 81% year over year and 32% above the previous annual record.
  • The 2018 tech selloff has put data center REITs on sale, but secular tailwinds should drive outperformance even if valuation multiples do not return to historical averages.

The data center REIT sector had a rough year in 2018. For the first time ever, its total return, -16.1% on an equal-weighted basis and -13.7% on a market cap weighted basis, was more than 650 basis points (or bps) behind the -4.5% and -7.1% total returns of the MSCI US REIT Index (Bloomberg: RMS G) and the S&P 500 (Bloomberg: SPX), respectively.* What happened, and should long-term investors in the space be concerned?

In late 2018, we posed these questions to the publicly-traded data center companies and many large dedicated and non-real estate dedicated experts. There was a strong consensus that the worst performing data center REIT, QTS Realty Trust (QTS), primarily sold off for company-specific reasons. QTS took a huge write-down on its cloud and managed services businesses in February, effectively guiding to a 15% roll-down in revenues as it became the last large public data center owner/operator to admit that it could not compete in the space with Amazon (AMZN), Microsoft (MSFT), Google (GOOG) (GOOGL), and IBM (IBM). For the rest of the data center REITs, there was a general agreement that drivers of underperformance were (a) the global tech selloff in 3Q18 and 4Q18 and (b) decelerating per share earnings growth and guidance for '18 and '19.

While we were frustrated by both (a) and (b), our discussions revealed that many investors sold data centers in 2018 because they feared that (a) and (b) were connected. Specifically, they believed that the primary causes of the tech selloff - lofty valuation multiples, decelerating top-line growth, angst over Chinese GDP and trade, and growing regulatory risk - were reducing cloud service provider (or CSP) and enterprise demand for data center space. This could not be further from the truth. In fact, our research indicates that demand for wholesale data center space hit an all-time high in 2018 and shows no signs of abating.

This article was written by

Chilton REIT Team profile picture
1.74K Followers
The REIT Team of Chilton Capital Management, a Houston-based investment adviser, is headed by co-portfolio managers Bruce Garrison, CFA, and Matt Werner, CFA. Mr. Garrison has over 40 years of experience analyzing public REITs both on the buy-side and the sell-side. Mr. Werner joined Mr. Garrison on the Chilton REIT Team in 2009. The REIT Team’s strategy primarily pursues investments in publicly traded real estate investment trusts (REITs) and real estate related entities based primarily in North America. The REIT Team believes public REITs are superior vehicles for investing in real estate due to their liquidity, transparency, and total return characteristics. Investing in public securities enhances the REIT Team’s ability to diversify by geography, sector, strategy, property, and tenant while maintaining portfolio liquidity. REIT property types include apartments, regional malls, shopping centers, lodging, office, industrial, self-storage, data centers/cell towers, and a variety of health care related facilities. The REIT Team focuses on traditional methods of security analysis; primarily research, critical thought and analytical depth, which are integral to their investment process. The REIT Team’s investment approach seeks to combine its real estate industry experience with traditional methods of security selection to make sound investment decisions in real estate companies. The Chilton REIT Team manages Separately Managed Accounts (SMAs) for high net worth individuals and institutions. Additionally, the REIT Team is the sub-advisor for an open-end investment company, the West Loop Realty Fund (tickers: REIIX, REIAX, and REICX). Before investing one should carefully consider the West Loop Realty Fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus and summary prospectus, a copy of which may be obtained by calling 800-207-7108. Please read the Fund’s prospectus or summary prospectus carefully before investing. The Fund may not be suitable for all investors. We encourage you to consult with appropriate financial professionals before considering an investment in the Fund. Liberty Street Advisors, Inc. is the advisor to the Fund. The Fund is part of the Liberty Street family of funds within the series of Investment Managers Series Trust. The Fund is Distributed by Foreside Fund Services, LLC. Chilton Capital Management, LLC is an independently owned and operated firm formed in 1996. Chilton provides investment advisory services for registered investment companies, private clients, family offices, endowments, foundations, retirement plans and trusts. For more information about Chilton Capital Management’s REIT Team, please visit www.chiltoncapital.com/reit/ or email info@chiltoncapital.com. Additional information about Chilton Capital Management LLC is also available on the United States Securities and Exchange Commission’s website at www.adviserinfo.sec.gov. The searchable IARD/CRD number for Chilton Capital Management LLC is 104592.

Analyst’s Disclosure: I am/we are long EQIX, CONE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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Comments (4)

IT Gal profile picture
Good article, though I caught it a month late.
Much of the outflow is likely due to people chasing yield. but....
Take it from a 25 year IT tech veteran (me), Datacenters and Cloud is the new thing. Just like Virtual (VMWare) and mass filer storage (Netapp/EMC) was just 8-10 years ago....

I work for one of the largest healthcare companies in the US and even though we host a massive amount of our own? We are moving full steam towards more cloud.
Many companies are, it's cheaper in the long run for them to have someone else host it...
And many house backup data at Switch (everyone from healthcare like us to PIXAR/Disney etc)...
But we, like others, are moving more and more towards Azure, AWS etc....we even created a whole new departmental team for it.
With healthcare growing and the move towards more online services, e-PHI etc? Cloud is the new wave. It's here, it's growing and it's not going anywhere.
gastro4 profile picture
Do you have on opinion on the Chinese Storage/Data Center stocks such as GDS and VNET?
Thanks
v
agreed ! Long CONE and IRM .. also like DLR.... :)
cyrano13 profile picture
Agree, except consolidation/acquisition is a game that is always in play.

Do you think any of the low density players will try to convert to REITS?

thx.
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QTS--
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