06/01/18 Barron's Knowledge

Data Centers Take Center Stage in Real-Estate Investing

Data center image

Barron's Sector Focus: May 18, 2018 Evie Liu

Screen Shot 2018-05-21 at 2.24.33 PM

As 10-year Treasury yields have climbed past 3%, investors have started seeing the impact on the equity sectors known for high dividends, such as utilities and real estate. The Dow Jones U.S. Real Estate Total Return Index (DJUSRET) has fallen 5.5% so far this year, while the S&P 500 Total Return Index (SPXT) added 1.5%.

Does this mean real estate is a no-go zone now? Not if you know where to look, according to Burl East, portfolio manager of the $318 million Altegris/AACA Opportunistic Real Estate fund (RAAAX). In 2017, the fund outperformed 98% of its peers with a 23.6% return, according to Morningstar. The fund has a three-year annualized return of 8.9% compared to the peer group's 2.4%.

Barron's met with East to talk about his investment strategy and vision for the real-estate sector in a rising-rate environment.

He thinks investing is like creating a recipe: Find the right ingredients and keep them the same. His favorite four ingredients: properties that are in constant demand; types of properties that are offered by just a few companies; high barriers to entry for new players; and high barriers to exit for tenants.

East looks for real estate markets where landlords can demand higher prices because of low supply, and where tenants are essentially at a disadvantage. "We don't invest in fair-fight; we look for something as close to a monopoly as possible where the tenant is denied choice," says East.

For example, data centers—the gigantic warehouses that hold vast numbers of computer servers that store, process, and distribute data.

With booming technologies such as artificial intelligence, virtual reality, and machine learning, the world is seeing rapidly increasing demand for more data storage and stronger processing power. The Internet of Things (IoT)—interconnected smart devices that include AI assistants and autonomous cars—will also generate much more data than we could ever have imagined.

"An autonomous car will need 40 times more bandwidth than the cars we use today," says East. "The demand for data centers is growing 30% per year in the U.S. and 70% in China, but there are only six public companies in the supplier's market." They are: Equinix (EQIX), CoreSite Realty (COR), CyrusOne(CONE), Digital Realty Trust (DLR), QTS Realty Trust (QTS), and Switch (SWCH).

Data centers aren't easy markets to enter. It's not hard to purchase a piece of land to build the property, but the facility needs to be outfitted in fiber, equipped with interconnected networks, and wired for massive electric power and top-tier security devices. It takes about $1,000 to build one square foot of data center, said East, compared with the average cost of $300 for conventional real estate.

The industry is also very much driven by trust and reliability. The last thing companies such as Facebook(FB) and Alphabet (GOOGL) or government agencies such as the Securities and Exchange Commission and Federal Bureau of Investigation want to see is a data breach. This makes it almost impossible for new companies with no established track record or reputation to break into the business.

"We'll keep the number of particants small, make sure that nobody else joins the club, and that existing members don't overbuild," East says.

Another key part of the formula is the high cost if tenants to change their mind. Unlike an apartment or storefront, where tenants can simply move out when there's a change in market dynamic or pricing, it's very risky and expensive for companies to leave a data center given the amount of infrastructure investment there.

To East, all these factors above make data centers a perfect investing opportunity in real estate, where landlords can easily control the supply and dictate the price. Data centers make up 22% of his fund's portfolio.

Other properties sharing the characteristics he likes include wireless towers (American Tower REIT (AMT), Crown Castle International (CCI), SBA Communications (SBAC), lab space, infrastructure facilities, toll bridges, and airports.

Beyond that, East says real estate in general is still a safe haven for investors: "The real-estate sector has offered fantastic returns across a variety of cycles, it's a reliable wealth generator."

The sector is also a good hedge against inflation. "A lot of properties have CPI escalators built in the lease, so the return you get are real numbers but not nominal value."

What else does the sector offer? Stability. "There's no tech revolution and upheaval, no labor union, less regulations," says East. "The ocean is always the same here."

All Knowledge Tags

$DFT $DRT 21013 acquisition report 350 E Cermak AT&T AWS AWS data center Amazon data center Ashburn Data Center Market Atlanta Data Center Leasing Atlanta Data Center Market BC Partners buying Centurylink data centers Barron's Data Center Real Estate Bitcoin Mining North Carolina Bitcoin Mining Power Rates Bitcoin Mining Washington Buys Data Center 2018 C7 Data Center CIO CIO Insight CIOForum CTO CTO Journal Carter Validus REIT Carter Validus sells data centers Centurylink Centurylink Data Centers Centurylink buys Level 3 Centurylink data center business Centurylink selling data centers Cloud Colocation CoreSite Crown Castle Cryptocurrency Mining Power Cryptocurrency mining space CyrusOne CyrusOne Atlanta data center CyrusOne Data Center Atlanta Cyxtera Technologies DLR buys DFT DRT Dallas Data Center Activity Dallas data center Data Center Data Center Acquisitions Report 2018 Data Center Activity 2018 Data Center Consolidation Data Center Investment Data Center Investments Data Center M&A Data Center Mergers & Acquisitions Data Center Purchase Data Center REITs Data Center Real Estate Investing Data Center Tax Incentives Georgia Data Center leasing report Data Centers Data center absorption 2018 Data centers DataBank DataCenters# DevOps Digital Bridge Digital Realty Digital Realty Trust Digital Realty Trust Atlanta Digital Realty Trust Chicago Digital Realty Trust Dallas Digital Realty Trust acquires Dupont Fabros Digital Realty Trust merger Digital Realty buys Chicago data center Digital Realty buys Dupont Fabros. Dupont Fabros Dupont Fabros merger Durham Data Center Equinix Equinix Dallas Equinix buys Infomart Equinix buys Verizon Data Centers F5 Networks Facebook Atlanta Data Center Facebook Data Center Ft. Worth Data Center GI Partners Georgia Data Center Legislation Google Hyperscale data center locations Hyperscale data centers Hyperscale growth IBM data centers IRM data center expansion Infomart Infomart Dallas Iron Mountain Data Centers Iron Mountain buys Fortrust Iron Mountain buys IO Data Centers Level 3 MapleTree buys data centers Microsoft Data Center Microsoft data center NXTVn New Chicago Data Center New Jersey Data Center Northern Virginia Absorption Oracle data center Peak 10 QTS QTS Data Center Atlanta QTS data center Santa Clara Data Center Sentinel Shaw Communications Switch Data Center Atlanta Switch data center Atlanta T5 Data Center Atlanta Telefonica TierPoint TierPoint# US Low Cost Power States US Power Grab US data center market report 2018 Vantage Data Centers Verizon ViaWest Virginia Beach Cable Landing Station Virginia Beach Data Center Park Virginia data center park Wall Street Journal Windstream Zayo ata center buys data center and colocation business buys data centers cloud data center data center acquisitions data center for lease data center for sale data center market data center outage data center real estate data center sale leaseback data center sales data center tax incentives data centers for sale delta data center delta outage digital content emerging data center trends hybrid cloud north carolina data centers