Data Centers: Investing In Where the Internet Lives

Advisors that directed portions of client portfolios to real estate this year – even basic concepts such as exchange traded funds – might be earning some year-end praise from clients because real estate will close 2021 as the second-best sector in the S&P 500 trailing only energy.

That's the good news. The tricky part, as advisors well know, is that sector leadership, particularly when it's not technology, doesn't always repeat from one year to the next. So it's reasonable that some clients might be pondering what's in store for real estate in 2022.

One of the obvious reasons for that apprehension is that interest rates are poised to rise – perhaps several times. Historically, real estate is one of the most rate-sensitive sectors and usually not in a good way.

The good news is that this isn't the real estate sector many advisors knew back when they initially got into the financial advice business. Like other groups, real estate is evolving – mostly for the better – and it's becoming more reflective of growth opportunities, including data centers. Let's explore that more here.

Dawn of the Data Center Era

One of the positives about the data center investment thesis is that many clients already have some familiarity with it thanks to stocks such as Nvidia (NASDAQ:NVDA) and, to a lesser extent though a still high-flying one, Equinix (NASDAQ:EQIX).

Data centers, which are massive buildings full of servers that store and transmit data, are essentially the backbones of the internet. Recent news flow confirms the validity of the data center investment thesis.

Meta (formerly Facebook, Inc.) is a prime example of that trend. In recent report, Tom Furlong, Meta’s President of Infrastructure - Data Centers, notes the company has 48 data centers and another 47 under construction.

“Holy mackerel - that sounds like a lot! We need to do some math: From 2010 through 2019, Meta invested over $16 billion developing data centers. It has continued to pour money into DCs for the past two years,” according to IO Digital. With plans to double its existing data center footprint, it’s safe to assume Meta has budgeted well over $25 billion for data centers alone over the coming few years!”

That's larger than market values of much of the S&P 500 and if Meta decided to be a dedicated data center company, it'd be one of the top players in the space. But there's more to the data center thesis, including deal-making. In recent weeks, deals worth $25 billion combined were announced for CoreSite (NYSE:COR) and CyrusOne (NASDAQ:CONE).

These points come on the heels of Blackstone’s summer 2021 acquisition of QTS for $10 billion (QTS is a direct competitor to CyrusOne),” adds IO Digital. “Since those announcements, we have also seen rumors of an imminent $11 billion acquisition of Global Switch, a privately held data center business. The CoreSite, CyrusOne, and QTS acquisitions are the three largest data center buyouts in history. Global Switch would expand that list to four. And they all happened in a six-month period.”

Long-Term Outlook Is Attractive

Traditionally, advisors allocate some of clients' portfolios to real estate as long-term, income-generating positions with inflation-fighting capabilities. Although data center yields are low, the approach should be the same for this growthier corner of the real estate sector.

Data centers offer incomparable scarcity premium (it's hard to build one of these structures in rapid fashion) and intersection with an array of other disruptive technologies. Bottom line: This asset class isn't going anywhere. It's getting stronger.

“Digital infrastructure assets continue to benefit from the exponential growth of the 'Internet of Everything' trend,” concludes IO Digital. “Each time we unlock more storage and delivery capacity, new use cases emerge to fill it. This reflects a seemingly insatiable human desire for the fruits of digital consumption. Families demand it. Businesses live and die by the success of their digital strategies.”

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