Research

The Technology Trends Powering Growth for Data Center REITs

Omotayo Okusanya
Senior REITs Equity Research Analyst
December 22, 2020

Data Center REITs now make up nearly 12% of the overall REIT index, up from only 2% a decade ago. That rapid growth makes the industry almost impossible to ignore—but it is also raising questions among investors. Can the sector’s growth continue? And if so, where is it going to come from?

Adding to the uncertainty is a belief that Data Center REITs could be impacted by the imminent, widespread availability of Covid-19 vaccines. There is  some concern demand for data centers could decline if we see a reversal in the massive shift to remote work and school, online shopping, and streaming entertainment that occurred during widespread stay-at-home orders.

We strongly believe those fears are overblown. When you look at broader social, technology and business trends, we are still in the early stages of the digital transformation age—and data centers remain central to this next technology revolution.

Emerging technologies drive cloud and IT outsourcing growth

Cloud computing requires massive date center installations to provide computing, storage and networking capabilities and is projected to continue its rapid growth as technology, social media and gaming companies compete for dominance. However, growth in Data Center REITs won’t simply come from the expansion of existing cloud-based applications in our view.

Emerging technologies such as artificial intelligence (AI), 5G, and the Internet of Things (IoT), are expected to make huge contributions to the global economy over the next decade—and these applications require substantially more data center capacity. For example, AI applications are estimated to require 10 to 20 times more computing power than typical cloud applications. 

On a smaller scale, businesses are poised to resume IT spending that had been put on hold during the pandemic. Gartner expects worldwide IT spending to rebound by 4.0% in 2021, compared to a 5.4% decrease in 2020. Given that half of corporations still maintain their own in-house data centers, we expect companies to take a closer look at data center outsourcing opportunities—especially given that 2020 proved that many employees can effectively work from home if the business has the right infrastructure in place.

Favorable supply and demand trends

Another favorable sign for Data Center REITs is that the absorption rate is exceeding supply in eight of the top ten U.S. markets. The U.S. market’s overall vacancy rate is now 7.1%—a five-year low and an indication of strong demand going forward. In response, many of the major Data Center REITs are in the midst of large development projects to meet demand, and we believe this is a good time for them to be adding capacity.

The supply and demand dynamic is also compelling when we look internationally. While regions such as Europe and Asia have higher vacancy rates, they also have lower penetration rates for cloud computing than the U.S. Efforts by major cloud computing providers like Amazon Web Services, Microsoft and Google to expand their global presence should absorb existing data center capacity and support further growth.

Benefits for both hyperscale and co-location facilities

Data Center REITs are split into two distinct markets: Wholesale/hyperscale facilities for customers requiring at least 2 MW of power capacity, and enterprise/co-location facilities for customers requiring 100kw – 1 MW capacity. The technology trends and supply/demand conditions are favorable for both markets.

Hyperscale facilities will continue to benefit from growing demand from social media companies and cloud computing providers. The cycle of growth in this market can be more “lumpy,” as hyperscale data centers often must absorb huge demand spikes, develop more capacity, and then wait to fill that space. But the long-term demand curve remains an upward slope.

Growth may be slower but is more predictable on the enterprise side where data centers have tens of thousands of potential customers that need to outsource their computing and storage needs. In this market, demand is largely driven by overall IT spending which, as we’ve noted, appears poised to resume its growth.

For these reasons, we believe that investors should focus on Data Center REITs with a global presence, operations in both hyperscale and co-location, and differentiated platforms to support the needs of established and emerging technology applications. This approach can help capture the growth in an industry that’s essential to the ongoing digital transformation of business and society.

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