Investors looking for the reliability of rental real estate but the growth potential of technology have an interesting opportunity in a niche area of the market where the two intersect: datacenter REITs.
If you don’t know what a “datacenter REIT” is, here is a nice, concise explanation: They are landlords that charge rent to companies for housing their servers. It’s a specialized niche market, and today, we’re going to take a look at four established players in the space.
What legally qualifies as “real estate” has taken a more expansive definition in recent years, or at least when it comes to qualifying as a real estate investment trust for tax purposes. Over the past decade, we’ve seen cell towers, billboards, document storage facilities and even prisons reorganize (or at least attempt to) as REITs. But of all of the “alternative” REITs to hit the market, datacenter REITs are the only category with what I consider to be long-term growth potential.
The popularity of smartphones and tablets and the rise of “the cloud” for data storage and processing will continue to boost demand for server resources. I am reluctant to recommend a long-term position in, say,Facebook (FB, Financial) or Twitter (TWTR, Financial) because social networking is changing quickly and it’s impossible to know in advance who the ultimate winners will be. But with an investment in a datacenter REIT, it doesn’t matter. You stand to profit from the underlying trend—the increased need for remote computing power in the age of hyperconnectivity.
Digital Realty Trust
The largest and most liquid datacenter REIT is Digital Realty Trust (DLR, Financial), with an $8.5 billion market cap. I would consider Digital Realty the blue chip among datacenter REITs.
As the largest player, Digital Realty has a diversified tenant base. Its largest tenant—CenturyLink—accounts for just 7% of its annualized rental revenue. The top 20 tenants account for less than half of total rent, and the top 20 tenants is fairly well diversified across sectors. If you’re looking for broad exposure to the datacenter sector in a single stock, Digital Realty is your best bet.
I recently highlighted Digital Realty as a REIT that consistently raises its dividend, noting that Digital Realty has grown its payout at an annualized 20.6% clip over the past five years. Your yield on cost—i.e. the current dividend divided by your purchase price—had you bought Digital Realty five years ago would be 13.3%…and a mind-blowing 61.9% had you bought 10 years ago.
At current prices, Digital Realty yields 5.3%.
DuPont Fabros Technology
Next up is DuPont Fabros Technology (DFT, Financial), the second-largest player in the datacenter space by market cap. DuPont Fabros sports a market cap of $1.8 billion.
DuPont Fabros released its second quarter earnings in July, and its results were outstanding. Adjusted funds from operations—a metric often used in lieu of accounting earnings for REITs—rose by 48% on a per share basis. Revenues rose by 14% in the first half.
DuPont Fabros is less diversified than Digital Realty, with " title="DFT"/>, Financial)+to+Stable%3B+Notes+High+Tenant,+Asset+Base+Concentration/9652227.html" target="_blank" rel="nofollow">7 of its 10 operational datacenters located in Northern Virginia. But like Digital Realty, DuPont Fabros is a dividend-raising machine, having nearly tripled its payout since 2012. DuPont has raised its dividend by 50% in the past year and at a staggering 69% annualized rate over the past five years.
Now, to be fair, DuPont Fabros started with a low dividend five years ago and actually had to cut its dividend in 2008, during the pits of the financial crisis. But the dividend growth rate since then has been impressive, and I expect more to come. The stock’s dividend payout ratio is just 58% of normalized FFO. At current prices, DFT sports a dividend yield of 4.8%.
QTS Realty Trust
Next up is a relatively small competitor in the space QTS Realty Trust (QTS), a smaller competitor with a market cap of $877 million. QTS is also the youngest REIT in the group, having gone public about a year ago. QTS currently has a portfolio of 12 data centers scattered across 12 cities.
In its short history, QTS has consistently paid a dividend and has even raised it once. The stock currently yields 3.6%.
With only a year trading, QTS is still something of an unknown entity. But thus far, the results have been stellar. Funds from operations rose 66% in the last quarter.
CorSite Realty
And finally we get to, CorSite Realty (COR, Financial), the smallest of the lot by market cap. CorSite has a market cap of $686 million and a property portfolio of sixteen data centers spread across eight markets.
CorSite has a much shorter operating history than Digital Realty or DuPont Fabros, being publically traded only since 2011. But during its short life, it has generated impressive results. Funds from operations have grown at a 20% compound annual growth rate, and dividends per share have grown at an even more impressive 40% compound annual growth rate. CorSite currently sports a yield of 4.2%.
CorSite has a diverse roll of tenants, and its top ten tenants account for about a third of total annualized rent. Its top tenant accounts for about 7.4% of annualized rent.
Are there risks in this space? Absolutely. In 2013, datacenter REITs were dumped by investors on fears that big technology companies like Google (GOOG, Financial) and Amazon (AMZN, Financial) would emerge as competitors, leasing out excess capacity to smaller companies, rather than customers, and to some extent this has happened. But a rising tide lifts all boats, and increased need for remote computing power should provide enough business for all.
Disclosures: Long DLR.
