04/14/2020 | by Sarah Borchersen-Keto

Data centers REITs were the top performer across the REIT industry in the first quarter of 2020, and the sector is expected to remain an investor favorite going forward as the coronavirus crisis underscores its vital and expanding role in an increasingly digital economy.

Data center REIT returns rose 8.8% in the first quarter as broader markets declined. For the year to April 13, returns in the sector were 12.4% higher.

Spencer Kurn, analyst at New Street Research, pointed out that “the secular tailwinds are so powerful for data centers…the thirst for data consumption seems to be unrelenting.”

According to Green Street Advisors analyst David Guarino, “historic returns have been driven by a secular demand story and recent Covid-19 resilience is attributable to the same forces in an even more virtual world than before.”

The coronavirus crisis is serving to fast-track trends that were already evident in the data center space, analysts said.

Equinix, Inc. (Nasdaq: EQIX) published a global survey earlier this month showing that 71% of respondents plan to move more of their IT functions to the cloud, with 66% of these respondents planning on doing so within the next 12 months.

“I think the level of (coronavirus) traffic is probably going to be a temporary shift, but I think what it does do is accelerate the process of an enterprise going down its digital migration strategy,” said Erik Rasmussen, analyst at Stifel. Companies will realize that they need to have more of their infrastructure and critical applications housed in an environment that can handle the sort of impact now being seen with the coronavirus, he explained.

Kurn agreed, adding that companies need to fortify their remote capabilities. “To do that you need a robust cloud infrastructure.”

He pointed out that current estimates point to about 65% of all corporate servers being located on-site, while only 35% have migrated to the cloud. He sees a “tremendous” amount of potential growth for data center REITs as corporate migration to the cloud increases.

Guarino at Green Street observed that the pandemic will likely “pull forward demand over the next few years as corporations position themselves for a potential repeat scenario in the future.”

Meanwhile, data center REITs enjoy “very well-positioned” balance sheets and sufficient liquidity to ride out the current dislocation, according to Rasmussen. At the same time, a high percentage of their tenant base is investment grade. “Data center operators are probably more immune to the rent referral or rent relief discussion than some of the other sectors,” he said.

Green Street’s Guarino agreed that data center REIT tenants appear to be financially healthy. “Limited disclosure makes it difficult to determine who exactly top tenants are, but odds are high the largest cloud and technology companies in the world are at the top of each REIT's tenant roster.”

Analysts also note that the data center space remains fragmented, pointing to future consolidation.

“Mergers and acquisitions continue to be a theme that resonates in this space. Once the dust settles you may see some of those assets that were distressed or weren’t investment grade be potentially very compelling,” Rasmussen said.