Viewpoint: Data Center REITs and the Quest for Connectivity

The data center REIT sector is at a watershed moment where big strategic bets are being made in terms of how best to invest resources in order to maximize real estate rental income streams tied to future connectivity.

For data center REITs, balancing the push for both scale in an individual market and expansion into new markets is tricky. Data center REITs have found that a large presence is necessary within each market to offer value to large tenants. At the same time, the more markets REITs can play in, the more rents they can collect. There is opportunity to outperform in terms of connectivity for REITs that build up capacity in domestic markets like Dallas, Silicon Valley, Northern Virginia, Chicago and New York, but other priority markets should also include London, Amsterdam, Dublin and Australia.

Getting this strategy right is made more complex by the pressure to redevelop and refurbish older assets.

The technological shifts and efficiencies often require new hardware that is part of structural components to buildings or changes to existing hardware, which requires significant investment for data center REITs in order to stay current. Plus, demand is set to outstrip supply, and that can create pressure to build hastily with short-term considerations in mind.

Connectivity is Key

Connectivity is paramount to the performance of data centers because it drives additional revenue (on top of more commoditized elements like space and power offered as part of leasing space to tenants) and because it is a powerful tool in customer retention.

Connectivity occurs when data centers connect two tenants wishing to share their data with one another or provide content to one another (much like sharing visitors of popular stores within a shopping mall). Consider players like major wireless carriers, device manufacturers or the makers of a popular app – they have data to share and they value data centers that facilitate these transactions securely and efficiently.

More and more REIT data center management teams are playing up the strength of their interconnections.

QTS heavily emphasized the benefits of their connectivity for customers on their third quarter earnings call and highlighted that connectivity revenue is growing annually at more than 15 percent. Digital Realty’s connected campus in Atlanta alone provides more than 11,000 interconnections between 300 customers, and the REIT has now updated its descriptor to “a leading global provider of data center, colocation and interconnection solutions.”

Fundamental Drivers Clear to All

The fundamental drivers for the broader space are clear to all. The number of connected devices is predicted to rise from about 6.4 billion in 2016 to almost 20.8 billion by 2020, according to technology research firm Gartner Inc. IDC, an information technology research company, predicts that the total amount of data produced globally will increase from 10 zettabytes in 2015 to 180 zettabytes in 2025, a 1700 percent increase over 10 years.

This growth is exponential, and while efficiencies mean that the need for new hardware and floor space aren’t directly proportional to the increase in data produced, the demand for more data center capacity and facilities is robust.

Google built the first data center in the United States with a footprint in excess of 1 million square feet back in 2011. According to an Institute of Electrical and Electronics Engineers (IEEE) working group research paper, building 1 million square feet data centers is “now the norm.”

Much of what the data center REIT industry is facing today feels like it could fall into the “nice problems to have” bucket. However, the big strategic bets made by the industry today will have long-term ramifications.

Samuel Sahn is Executive Director, Portfolio Managment/Research, Global Real Estate Securities, and New York City lead at Timbercreek Asset Management.