Although the entire real estate investment trust (REIT) sector has come under pressure recently, data center REITs have the added negative of a hedge fund manager questioning the industry’s outlook. That may present a buying opportunity for a sector that has years of growth ahead.
Barron’s recently reported that hedge fund manager Jonathon Jacobson of Highfields Capital Management is not only questioning the accounting of data center REIT giant Digital Realty Trust, Inc. (NYSE:DLR), but is also suggesting that the entire sub-sector is facing strong headwinds. The accounting concerns are a specific negative for Digital Realty, which has fallen from the high seventies to the low sixties over the last few months. The broader fear, however, may be overblown.
The data center REIT model is based on the trend toward increased use of the Internet. Since computers can be accessed over vast distances, there’s little need for every company to have their own in-house network. Specialists like Digital Realty Trust, Inc. (NYSE:DLR), DuPont Fabros Technology, Inc. (NYSE:DFT), and CoreSite Realty Corp (NYSE:COR) can provide a home for such networks, allowing the companies to use the Internet to access their information.
These REITs, however, don’t just house boxes, though that is one way to use their services. Data centers also offer multiple locations (redundancy), backups, staff to maintain the computers, and the ability to share expenses to keep costs down. That’s a compelling offering for companies looking to pare back their IT budgets.
Big Player Problems
One of the concerns is that larger customers are increasingly building their own data centers. That has, in turn, reduced demand and hurt pricing. While this may be true in the short-term, it doesn’t tarnish the longer-term view for the industry. Indeed, the market isn’t only made up of big players like Google Inc (NASDAQ:GOOG) and Amazon.com, Inc. (NASDAQ:AMZN), there are thousands of small- and mid-sized companies that want to use data centers, too.
And, large companies may find that owning their own data centers isn’t as desirable as they had hoped because the buildings trap capital that could be used elsewhere. Eventually they may want to sell their data centers to free up capital for other purposes. Data center REITs would be obvious buyers.
The Big Player
Digital Realty Trust, Inc. (NYSE:DLR) is the largest player in the space with over 115 properties. It has a global footprint, with about 80% of rents coming from North America and the rest from Europe, Asia, and Australia. It has some big name customers, including International Business Machines Corp. (NYSE:IBM) and Facebook Inc (NASDAQ:FB), that could take their data centers in-house.
However,Digital Realty Trust, Inc. (NYSE:DLR) has over 500 tenants. So, even if it lost some large customers, it has plenty of others to pick up the slack. In fact, the company expects data center demand to increase by at least 20% annually in the regions it serves, so demand shouldn’t be an issue.