Are The Days Of The Public Data Center REIT Numbered?
Are public data center REITs on the verge of extinction?
Reports emerged this week that data center real estate investment trust CoreSite is exploring a possible sale — news that comes on the heels of similar acquisition rumors surrounding CyrusOne and the now-completed sale of QTS Realty Trust. There were five public data center REITs at the beginning of 2021 — and soon there may be just two.
Speaking at Bisnow’s DICE East event, industry insiders said there is a strong possibility that the remaining public REITs in the data center space will follow this same path. In addition to the wave of cash-flush private equity firms hungry for digital infrastructure, REITs may have other reasons to flee public markets — and soon — as impending interest rate hikes threaten to disproportionately affect their valuations and their inability to take on debt undercuts development efforts.
The data center finance landscape, they said, may soon look very different.
“It’s changing for sure,” said John Dobo, Landmark Dividend’s senior vice president of digital infrastructure, speaking at DICE East. “I think all the major REIT operators are looking at potentially selling.”
Reuters reported Tuesday that CoreSite Realty Corp. has fielded multiple acquisition inquiries and is working with a major investment bank to evaluate its options. The offers for the Denver-based company reportedly came from private equity firms, as well as digital infrastructure corporate American Tower and fellow REIT Digital Realty Trust.
While the terms of these offers are unknown, experts tell Bisnow that companies like CoreSite and CyrusOne are likely seeing offers at more than 20 or 30 times revenue, as private equity funds and other investors eager to buy digital infrastructure assets flood into the marketplace with checkbooks in hand.
Landmark’s Dobo points to Blackstone’s deal in June to take QTS private — the $10B deal was 21% over QTS’ stock market valuation. That kind of price is not an outlier, he said.
“I think they paid market price, and it just shows where things are right now,” Dobo said. “People are paying hand over first to get into the market.”
According to Dobo, Landmark, which internalized its own digital infrastructure-focused REIT this year, is seeing twice as many offers as expected on deals in the data center space. It’s an observation echoed by Jim Grice, a partner and co-leader of the Global Data Center and Digital Infrastructure Team at Bryan Cave Leighton Paisner.
He said the unprecedented level of interest is meeting a lack of available assets and investment opportunities, which has driven up what investors are willing to shell out to get into the game.
“There’s so much institutional capital trying to find a home,” he said at DICE East. “We’re seeing a massive uptick in interest level, and there’s a huge supply of cash but not as much product as the dollars want.”
While the flood of investor capital may be the primary driver of any future REIT acquisitions, there are other forces pushing companies like CoreSite away from public markets. One of the most significant looming likelihoods is the Federal Reserve raising interest rates, which have an outsized impact on the stock price of companies with a REIT structure, analysts say.
With inflation rising, traders in futures markets said yesterday that they expect the first interest rate hike to occur earlier than the Fed previously indicated — somewhere between July and September, with the second rate hike expected by December 2022.
“If the market is accurate and rates rise sooner, then that will put downward pressure on valuations as rising rates will increase costs,” said Rashad Kawmy, a partner at Boundary Street Capital who specializes in lending in the digital infrastructure space. “That will create pressure on all elements of the ecosystem.”
According to Kawmy, exiting public markets would also make REITs more competitive for development deals — particularly the large development contracts with hyperscale cloud providers that are increasingly the backbone of the data center industry.
At present, Kawmy said, REITs are often held back by the debt aversion of stock market investors, and that has put even giant investment trusts like Equinix at a competitive disadvantage in the superheated, and somewhat speculative, hyperscale development landscape.
“The biggest difference between public and private markets is that public markets have a pretty low tolerance for leverage and private markets have a very high tolerance for leverage with these kinds of businesses,” Kawmy said.
“Some of these public REITs have been outcompeted by private levered developers for high-quality development projects — a lot of them hyperscale tenants — so moving from being public to being private gives more access to debt capital, reduces the overall cost of capital for that business and will allow them to compete with the private developers.”
Despite what he characterizes as a strong case for exiting public markets, Kawmy emphasizes that publicly traded data center REITs are not facing an inevitable impending disaster. Indeed, companies across the sector reported strong Q3 earnings and year-to-year growth north of 10%. And with seemingly insatiable demand for their product, experts claim their fundamentals remain strong.
“Most large REITs reported that they’ve never had such big backlogs for hyperscale development than they have right now,” Kawmy said. “Every year we think the hyperscalers can’t want more, and somehow we’re always at the largest backlog of the pipeline.”