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Data Center REITs May Be Surging Now, But Challenges Await

Wall Street continues to love data center REITs, but private equity money flooding into digital infrastructure may pose new challenges that REITs are ill-equipped to meet. 

Large data center real estate investment trusts like Equinix and Digital Realty, which own more than half of the world’s data centers, have continued their explosive growth that began with the onset of the coronavirus pandemic.

But industry insiders tell Bisnow that the major REITs may end up ceding ground to fund-backed companies that can scale more readily, better adapt to innovation, and offer a range of services beyond physical data centers.


“You’re seeing more private data center providers competing for the same dollars as Digital Realty or any of those guys, and some of that money is now going to companies like Digital Bridge, which is the money behind a number of data center providers, power companies and things like that,” said David Spiewak, founder and CEO of data center advisory firm DJS Group.

“These are private companies whose costs of capital are potentially less than the public REITs, and they're starting to pick up that share of demand.”

Data center REITs became a safe haven for investors during the pandemic. Demand for data centers exploded as companies scrambled to adapt to an increasingly virtual world. At the same time, long-term investors like pension funds, which looked to REITs as reliable investments with frequent dividends, turned to data centers as other real estate sectors became suddenly volatile and uncertain. 

As large companies increasingly move toward the cloud for data processing and storage, REITs’ rosters of tenants have also swung heavily toward hyperscalers like Amazon, rather than retail enterprise clients. These long-term leases to the most creditworthy companies have given investors additional confidence in data centers as a safe bet.

“The majority of the absorption globally is from a limited number of users,” Spiewak said. “You’re getting longer-term contracts from investment-grade organizations like a Google, Amazon, Microsoft or Oracle, so it becomes a safe haven far more so than multifamily or industrial where you’re more worried about growth.”

In recent weeks, low yields on 10-year Treasury bonds have pushed more investors toward data center REITs due to both their safety and the dividends they are required to pay out. 

While there is near consensus that demand for data centers will continue to grow, industry insiders suggest that the big REITs may face headwinds in the near future.

More and more, the most dynamic players in the digital infrastructure space are not the public investment trusts but private companies on the receiving end of a seemingly endless supply of investor capital, according to Kevin Imboden, director of research for the Data Center Group at Cushman & Wakefield.

“They’ll do a stock issuance and it’ll be oversubscribed several times, or they’ll need a minority investor and five come out of the woodwork who want to give two hundred million,” he said. “It’s pretty amazing because we’re talking to these funds and every week there’s a new one saying they also want to put $200M into data centers.”

REITs may find themselves at a competitive disadvantage to fund-backed companies like Digital Bridge, which launched in June,  David Spiewak said. While REITs are required to derive nearly all their income from their real estate holdings, other companies can offer additional digital infrastructure services along with their data centers. For potential tenants, this consolidation can mean a lower price point and streamlined operations.

“A company like Digital Bridge has hyperscale, retail, wholesale, they own towers, they own fiber companies, they’re a global delivery tool and they have edge,” Spiewak said. “They can offer you a solution on everything, versus just offering you space and power.”

This consolidation of digital infrastructure companies is expected to gain momentum in the months ahead, industry insiders told Bisnow. They point to retail colocation provider Evoque, owned by Brookfield Capital, which purchased cloud service firm Foghorn earlier this month. 

“My horizon says the M&A activity is going to pick up next year more and there’s going to be more consolidation,” said Allen Tucker, a former managing director at JLL who now runs data center consultancy DC ConnX. “The guys who hold this long-term equity, these infrastructure funds, are going to become more predominant in this market space — they’re going to be aggregators.”

There is also the question of so-called edge technologies — whether 5G, the Internet of Things, or innovations like self-driving cars will lead to a less centralized model of data infrastructure — which hangs over all owners of large data centers. But analysts agree that diversified firms, whether private like Digital Bridge or public like American Tower, are in a better position to adjust quickly to a new reality that moves away from centralized data processing.

Fund-backed companies also have an advantage over public REITs in that they can spend money upfront for capital expenditures or R&D without having to worry about the short-term bottom line, according to Imboden. They can operate at a loss to find global expansion, whereas public companies have to weigh the benefits of expansion against the consequences of the resulting poor quarterly earnings reports. 

“In the long run things might be great because you moved into five new regions, but in the short term maybe your earnings didn’t look so good because you spent so much on development,” Imboden said. “We’re going to see this with public companies looking at scaling globally but saying: We don’t want to be slammed by the analysts when we take a loss when we do it.”

Imboden and others say some public REITs may ultimately have more value than private companies. Indeed, Blackstone Group is attempting to take data center REIT QTS private in a $10B deal announced in June. It’s the kind of deal Spiewak expects to see more of in the months ahead. 

“Are more going to be taken private? Yes,” he said. “We’re going to see more of that and we’re going to see a lot more consolidation.” 

CORRECTION, July 14, 6 P.M. ET: A previous version of this story incorrectly named Blackrock Capital, not Blackstone Group, as the company taking QTS private. The story has been updated.