Why We Don't Invest In Data Center REITs

Important Note

Before going into today's article, I wanted to let you know that we will soon conduct interviews with the management teams of the following REITs:

• Farmland Partners (FPI)

• Whitestone REIT (WSR)

• Easterly Government Properties (DEA)

• NewLake Capital Partners (OTCQX:NLCP)

• BSR REIT (HOM.U:CA / OTCPK:BSRTF)

Let me know if you have any questions for them and I will make sure to ask them for you. You can put your questions in the comment section below.

Thanks!

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Why We Don't Invest In Data Center REITs

At High Yield Landlord, we have largely avoided investing in data center REITs. We admit that we have missed out on a strong rally from this sector over the last decade or so as the amount of digital data stored in the cloud has exploded.

The two pure-play data center REITs on the market today, Digital Realty (DLR) and Equinix (EQIX), have massively outperformed the real estate sector (VNQ) over the last ~15 years.

Data by YCharts

Certainly, as cloud data storage has gained widespread adoption and artificial intelligence applications such as ChatGPT have taken off, demand for data centers has soared.

And yet, we think the fundamentals for data centers is not as strong as the market thinks. Much of the strong price performance from data center REITs has been based more on investor sentiment than growth in profits. We know this is the case based on their rising valuation multiples:

Data by YCharts

DLR has especially seen its cash flow multiple expand to its highest level on record recently on the back of AI optimism.

The markets are pricing in a lot of future profit growth. But is it reasonable to believe that a sufficient amount of future growth will manifest in order to justify these valuations?

While it is possible that we are too pessimistic about data center REITs, we think there's an argument to be made that the market is too optimistic about them. We think data center REITs' future growth rates may turn out to be much more modest than the market thinks.

Let's discuss our reasons why.

Growing Demand And Supply