Real estate has been known for a door and four walls. Now, in today’s information age, it has expanded beyond restrictive square footage to high-tech sectors connected by grounded towers, vast miles of cable, and data centers exchanging information. Consider this new-age core to help you build today’s 21st century real estate portfolio.
Tech-influenced REITs explode over last five years
We are lumping data center REITs, tech-based infrastructure REITs, and industrial REITs together to highlight real estate’s transformation. At the turn of the century, industrial took a small piece of the pie, but starting in 2013, data centers and infrastructure joined industrial to form a tech revolution. Funds from operations (FFO) for these three sectors totaled 22.6 percent of FFO of All Equity REITs in 2018 – a 7.9 percent increase from 2013. Also, FFO hit $14.5 billion last year, a roughly $10 billion increase from five years earlier. Any way you slice it, that’s supersonic growth. And investors have reaped the benefits. Cumulative 5-year total returns were over 130 percent for these “tech” REIT sectors, compared to 75 percent for All Equity REITs.1
The “cloud” actually lives on the ground in data centers
Data centers consist of “server walls” that house electronic communication pushed through the cloud – yes, the data may travel in the air, but it eventually has to reach land. As you assess real estate’s reaction to slowing growth and a tight labor market, note that data center demand does not depend on consumer spending, U.S. and global GDP growth, jobs, or even interest rates. Instead, future growth will rely on enterprising big data, the advent of artificial intelligence, the explosion of 5G, and the Internet of Things. We really do live in a different world.
In 2017, investors must have felt like they were hitting every green light – a 28.4 percent total return compared to 8.7 percent for the broader public REIT market. Yet, 2018 brought underperformance compared to public REITs in the year where “nobody” made any money (-14.1 percent vs. -4.0 percent). Amazon and Microsoft saw cloud revenue decline, pushing many investors for the exits under the assumption that demand would follow. Yet, sentiment didn’t match fundamentals, as net absorption in the largest U.S. markets actually set a record in 2018, climbing 81 percent year-over-year and 32 percent above the previous annual record.2 Data center REITs have broad corporate appeal, as they can own and develop land in targeted markets, creating campuses where a who’s-who of enterprise clients are commingled to take advantage of scale.
As with many sentiment-induced sell-offs, promising fundamentals eventually have pushed data center REITs higher in 2019, even outpacing surging equities through the first quarter.
See a cell tower? Odds are, a REIT owns it
Cell Tower REITs own 50-to-80 percent of the 100,000-to-500,000 investment-grade cell towers nationally, giving them high importance in market cap-weighted real estate indices.3 Consumers want speed and mobility, but the tenets of data transmission make satisfying both increasingly difficult. For speed, a 5G small-cell network requires thousands of miles of underground cables or even more small-cell base stations. When thinking of mobility, a wide-reaching cellular network using turbo-charged transmitters requires a network of towers, each with wide-reaching capabilities. For now, a blended approach is ideal to meet this growing demand.
Three reasons to be bullish on cell tower REITs include the exponential growth of mobile data demand powered by continually-improving technologies, the staying power of macro cell towers to provide wide and continuous coverage – even in the age of 5G, and the rapid densification of adding more networks to existing towers, potentially improving revenue profiles with minimal additional costs.
Cell tower REITs also have several late-cycle investment advantages, most notably long-term, non-cancelable leases with built-in 3 percent escalators.2 They have minimal interest rate sensitivity and moderate sensitivity to economic changes. And, as some have noted, companies may further depend on 5G networks to increase the efficiencies of global companies depending on the severity of the next downturn.
Embracing a new-age real estate strategy
Real estate is a powerful diversifying agent in any investment portfolio, but with core sectors like office and retail hitting supply-and-demand, late-cycle headwinds, looking elsewhere for value should include an evaluation of tech-powered real estate. As the economy shifts, real estate professionals can deftly transform the use of land to meet increasing demand. Also, sectors such as data center and cell tower REITs require far less “square footage” and can leverage technology to minimize costs, enhance revenue potential, and improve your potential returns.