A real estate investment trust (REIT) is dedicated first to income. It is required to send 90% of earnings back to investors in the form of dividends. This means it’s unusual to find a REIT that also offers capital gains. But I’ve found just such a place.
Data Center REITs offer hosting, colocation and cloud on-ramps to enterprises and Internet Service Providers. They act as a sort of glue among the Cloud Czars, like Amazon (NASDAQ:AMZN) and Microsoft (NASDAQ:MSFT).
If you do a Google search for something and then buy it on Amazon, the request and response likely went through a data center REIT. The data centers hosted by REITs aren’t all cloud-based, but they usually require connections to clouds, and this is the best way to get them.
The colocation market alone continues to grow at 10% each year, driven by the needs of the Cloud Czars, according to Synergy Research. This was a $34 billion market last year.
It’s part of a larger trend in which the Cloud Czars are taking over the telecommunications market.
If your portfolio seeks both income and capital gains, here’s where you can find them in data center REITs.
Equinix (NASDAQ:EQIX) was founded in Redwood City, California in 1998 and has focused on global services almost since its inception. It has a market cap of $39 billion, and last year delivered $9.84 per share in dividends to its shareholders.
To a current buyer that’s a yield of just 2.16%. But five years ago, the stock was trading at $172 per share. It was trading April 4 at $465. If you bought some shares five years ago, the current dividend would give you a yield of 5.75%. Plus, there’s that capital gain, almost 30% per year, doubling what you would have gotten from the average NASDAQ stock.
This is key to successful income investing. Don’t just focus on the current yield. Let time work for you. If you’re on the right side of a trend, you are almost certain to prosper.
Last year, Equinix had revenue of $5.09 billion, up from $2.44 billion in 2014, and it brought $365 million of that to the bottom line. The asset base has more than doubled, to $20.24 billion, and while there is $9.44 billion in debt on those assets, the debt-to-asset ratio has been improving.
Equinix continues to grow its international footprint, most recently with a new Australian center. Its DC1 building in Virginia was the first large greenfield center to open, 20 years ago, back when such centers were mainly selling themselves as a way for corporations to speed data flows for things like video conferencing, or as alternatives to the Network Access Points (NAPs) that then dominated internet switching.
Equinix is not a huge acquirer, its most recent buy being Metronode in 2017. But that means that other companies’ shareholders aren’t getting a big chunk of your gains and that the stock isn’t being watered down with new shares.
All this makes Equinix one of the best data center REITs to buy.
Digital Realty Trust (DLR)
Digital Realty Trust (NYSE:DLR) was formed as a public company in 2004 out of 21 data centers acquired out of bankruptcy by GI Partners, a private equity firm. It now has 214 centers with 34.5 million square feet of rentable space in the U.S. and Europe.
On April 4, it had a market cap of $26.75 billion, and last year delivered $4.32 per share in dividends to investors. That’s a yield of 3.55%. Add a 19% one-year gain in the stock price and you get a total return of about 22%. Over the last five years, the stock is up 137%, and if you bought in 2014, when the price of the stock was about $60 per share, your current yield is about 7.2%.
In 2018, Digital Realty had revenue of slightly over $3 billion, with net income of $341 million, meaning 11% of revenues became net income. The company’s assets are worth over $23.7 billion, with $11.1 billion in debt, a slight improvement over 2014. Operating cash flow has also doubled.
The company’s biggest deal came in 2017, a $7.8 billion agreement to buy DuPont Fabros Technology. But the company quickly came back for more, buying Ascently, based in Brazil, last year for $1.8 billion. The company also broke ground last month for its third center in Singapore.
Brad Thomas of iREIT Investor notes that, while Digital Realty is an aggressive acquirer of data centers, it doesn’t account for acquisitions aggressively, which means it’s not stressing its balance sheet at the expense of the long term. Thomas calls Digital Realty’s global footprint a big advantage, and its size let it carry $236 million of empty land in fast-growing northern Virginia on its balance sheet. Thirteen of the 25 analysts currently following DLR have it on their buy lists.
CoreSite Realty (COR)
CoreSite Realty (NYSE:COR) is much smaller than Equinix or Digital Realty, with a market cap of $5.3 billion. CoreSite was born from two “telecom hotels,” as they were called then, in 2001, in San Francisco. It was then called CRG West, and the location was where Internet Service Providers hooked into phone networks, and where enterprises could go for big bandwidth.
CoreSite went public in 2009, and then began expanding internationally, starting in London. Its early expansion was funded by the Carlyle Group, a private equity firm. They reduced their interest to about 29% in 2016.
The small size of CoreSite Realty, relative to Digital Realty and Equinix, does give it some big advantages, in the form of capital gains. The shares are up 261% in the last five years, while dividends have tripled from 36 cents per share in 2014 to $1.10 now. That dividend yields a fat 4.4%.
CoreSite is the right stock for you if you’re mainly looking for exposure to the U.S. internet market. It is, like the other REITs, a great long-term holding. It’s expected to raise the dividend again, to $1.29 per share, in May. It bills itself as offering “hybrid cloud solutions,” with its close connections to big clouds like Amazon and Microsoft, and colocation services for enterprises building their own cloud systems.
QTS Realty Trust (QTS)
Smaller market caps can deliver big gains, as CoreSite shows, but there are downsides. A strategic shift can take a stock down hard.
QTS Realty Trust (NYSE:QTS) made that kind of shift in 2017, moving from managed services to being a “cloud on-ramp.” The company insisted the new plan would mean big new opportunities, but these have taken time to develop, with repeated misses on earnings estimates taking a toll on the stock.
QTS began life in Kansas, in 2003, expanded into Atlanta through a 2005 acquisition, and now has 25 data centers with 5.7 million square feet of rentable space. QTS went public in 2013 and has since doubled in price, while the dividend has also doubled to its current 44 cents. That represented a yield of 3.93% on April 4, and the company’s market cap stood at $2.83%.
QTS’s earnings misses have the stock trading at just 7 times revenue, and if it does beat estimates when it reports in May, it could shoot up. Analysts are expecting 54 cents per share, after losing 2 cents per share in the last quarter.
All this makes QTS the most speculative of the data center REITs. There are opportunities here, both in the success of its strategy shift and its continuing weakness, which could make it a prize for a larger company. A single transaction can transform an investor’s play from the weakest stock on the block to a big stake in one of the strongest.
Like QTS Realty Trust, CyrusOne (NASDAQ:CONE) is an underperforming company that is said to be attractive to acquirers. But unlike QTS, where the weakness comes from its own strategic shifts, with CyrusOne the weakness comes from its history of being privately held.
CyrusOne wasn’t publicly traded until 2013. Founded in 2001, it was bought by private equity players ABRY Partners in 2007 and then by Cincinnati Bell, a small phone company, in 2010. It went public in 2013 and by 2015 Cincinnati Bell had sold out its stake.
The company today has 45 data centers, mostly in the U.S., but it also has operations in Europe and Singapore. It expanded into Europe through the 2018 acquisition of Zenium for $442 million.
CyrusOne stock has been weak since last September, falling 21% since issuing what was considered weak earnings guidance, $3.10 per share instead of the $3.50 expected. Because REITs must pay out 90% of earnings as dividends, this meant a significant dividend shortfall.
A business that began with small warehouses in central cities, where phone exchanges interconnected, is now built on finding big parcels of empty land near where cloud giants intend to build. A modern data REIT must acquire land and build ahead of demand, competing with other REITs, private equity companies trying to build new REITs from scratch and the cloud owners themselves.
It’s the weakness of results, a dividend of 46 cents per share yielding 3.51%, that drove CyrusOne down. But it’s that same weakness that now has some speculators betting it will be acquired, which keeps the price of the stock up.
That’s the way it is in the data center REIT business, where the only constant is growth and the clouds rule.
Dana Blankenhorn is a financial and technology journalist. He is the author of a new mystery thriller, The Reluctant Detective Finds Her Family, available now at the Amazon Kindle store. Write him at [email protected] or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in AMZN.