Market Spotlight: Data Center REITs
Data Center REITs Benefit From Financial Service Demand; Credit Crisis Keeps Supply in Check
Tuesday April 8, 4:13 pm ET
By J.W. Elphinstone, AP Business Writer
NEW YORK (AP) -- Real estate investment trusts focused on data centers may avoid a bad turn as the economy slows, thanks partly to increased demand from a surprising corner: the beleaguered financial services industry.
Analysts from Raymond James, UBS AG and KeyBanc Capital Markets are bullish on the heavyweight of the subsector, Digital Realty Trust Inc., which buys, redevelops and manages technology-related real estate.
"We believe Digital Realty is well-positioned to capitalize on increasing absorption and rising rental rates as the company brings its redevelopment pipeline to market over the next three years," said Raymond James analyst Paul Puryear, who maintains an "Outperform" rating on the stock.
So far this year, the company's shares have fallen 2 percent, while the S&P 500 declined 6.7 percent and the EPRA/NAREIT North America index lost 2.5 percent.
The management of the San Francisco-based REIT recently told KeyBanc analyst Jordan Sadler that space demand from the financial services industry accelerated significantly in the past two to three months, even as the sector reeled from a six-month credit crisis and volatility in the stock market.
These companies continue to need data center space for replicated trading platforms, risk management and needs related to the Sarbanes-Oxley Act, Digital Realty said. Most corporate data centers, built before the technology bust earlier this decade, are outdated and can't handle the requirements of today's processing systems.
"Financial services companies no longer want to utilize their own balance sheets to build data centers when they can outsource and pay rent," Sadler said in an interview. Sadler keeps a "Buy" rating on Digital Realty's stock.
Demand from content delivery providers like Facebook, system integrators like Computer Science Corp. and other corporations have also propped up demand.
Puryear and Sadler also like DuPont Fabros Technology Inc., which went public in October and, unlike Digital Realty, develops its data centers from the ground up. Its main tenants are Microsoft and Yahoo Inc. Management recently reassured investors and analysts that the potential buyout of Yahoo by Microsoft wouldn't affect its tenant mix.
The stock, year-to-date, has lost 12.2 percent, but Puryear expects the newly minted REIT to close the gap between it and Digital Realty during the year as it leases up its new development.
"We believe DuPont's growth strategy of developing Internet-centric, wholesale data centers positions the company to deliver double-digit earnings growth over the next few years," Puryear said.
Other competitors in the space include non-REITs Savvis Inc. and Equinix Inc., which are Digital Realty's first and third largest tenants that sublease their data center spaces in smaller pieces. Their stocks have been crushed this year, plunging 31.4 percent and 26.8 percent respectively, as investors believe IT spending will slow and these two will be caught in the crossfire.
As for Digital Realty and DuPont Fabros, Citi analyst Michael Bilerman believes their risks include high tenant concentration and the threat of technological obsolescence. A prolonged credit freeze could also dry up demand as companies cut spending. The analyst maintains a "Hold/High Risk" rating on both stocks.
However, Sadler points out the tumult in the credit markets could have an unintended benefit: keeping supply in check.
"We were heading into an environment where prospective supply was a little bit of concern, but then came the credit crunch and speculative supply was scaled back," he said.
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