This Month in New Economy Real Estate: Cell Towers and Data Centers
By Christopher Gannatti, CFA
WisdomTree has a platform of different thematic investment strategies, and really any thematic strategy has its own infrastructure requirements. Information technology megatrends – think cloud computing, 5G connectivity, the Internet of Things or even artificial intelligence – can seem wrong need infrastructure in the same way as the megatrends involved in making things more physical, but they do.
Many of these megatrends could not function to the degree we are used to without cell towers and data centers.
New Economy Real Estate vs. Old Economy Real Estate
This year has been defined by the macroeconomic landscape, and inflation tops that list of determining factors. In a context of high inflation, real estate is an attractive asset class.
First, we saw how markets favored cash flow over the concept of possible future earnings. Many types of real estate investments are known for their ability to generate cash flow.
Second, there is the fact that, in typical inflationary environments, one should focus more on real assets – assets whose value should increase at least in line with inflation. Real estate value has been known to do this over time, although we can never guarantee that it will always do so in the future.
But if we peel back the layers – after the Covid-19 pandemic, are we as excited about shopping malls and old-fashioned office buildings as we once were?
In our view, “new economy” real estate is defined by the physical infrastructure that must exist for the various megatrends that people already believe in to continue to thrive. Two of the most important focal points of megatrend infrastructure are:
When considering cell tower real estate in 2022, the key attributes are incredible visibility into business cash flow and also very low economic variability. These companies tend to enter into very long-term contracts. They also tend to operate in the investment grade debt segment.1
If we think beyond the difficulties of the current macroeconomic situation, we can see that we are in the early stages of the global rollout of 5G. Over the years we’ve seen 2G, 3G, 4G… and now we’re seeing 5G.
Major global network upgrade activities began in 2021, and while we can’t know for certain how long the upgrade cycle will take, it could be in the order of 5-7 years as a forecast. within reason. There are usually software and hardware items with these upgrades.2
The business model for cell towers is quite simple, in that entities that want to use the hardware – like telecommunications companies – will pay regular fees to do so.
If we think of “data as the new oil,” it is like how energy producers pay pipeline companies to use infrastructure. It is interesting to consider the difference between US and non-US companies in how they tend to manage inflation:
- American companies have tended to sign agreements with longer, multi-year terms and fixed annual indexations of 3%. In past years, it was excellent. Years when inflation is at or near double digit levels, of course, are less ideal.3
- Non-US companies tend to see transactions with uncapped escalations pegged to various measures of consumer price inflation.4
Another point – investors may be curious about the difference between focusing more directly on companies that, for example, provide 5G services, versus companies that provide the infrastructure that allows data to be transferred more efficiently.
It should be noted that, for telecommunications companies in particular, the rates they can charge consumers are highly regulated. These companies are also forced to make huge capital outlays to be able to say they can at least match the best network capabilities.
Cell towers may not have the same visibility, but we return to our original note on visibility and limited cash flow variability. Remember, it’s more about the pipes being needed than what exactly goes through them.
If readers take away one point about data centers from this article, it’s that they’re all about scale. If we think today of Equinix (EQIX) and Digital Realty Trust (DLR), we must recognize that they are global platforms without equal. Operating a new data center today on a small scale would be a horrible undertaking. Equinix’s data centers, spread across many countries around the world, act as the backbone of the Internet.
Some might wonder why the world’s biggest companies, like Microsoft (MSFT), Amazon (AMZN) and Alphabet (GOOG) (GOOGL), can’t just build their own data centers? Why do they have to pay Equinix or Digital Realty Trust? We can agree that the bargaining power of data center providers against these companies hasn’t been high historically, but in 2022, it’s worth noting that some things are changing.
- Internet traffic has increased.
- The supply of the right types of semiconductors for use in data centers has remained limited.
- It is not necessarily straightforward to increase the capacity of existing data centers or to build new data centers in the right places, at least not with sufficient speed to meet demand.
If we consider the supply of data centers as the supply of, for example, commodities, then if the supply is tightening and the demand is stable or increasing, then the price should tend to increase. 2022 may see one of the strongest growths in data center pricing power in recent history.5
We also note an interesting practice we saw from Equinix, again one of the biggest players in the space. Equinix actually covers about two years of its projected energy demand. This means that customers will not have to pay the full cost of energy price increases. At a time when energy prices have risen dramatically, this is a very attractive policy to consider.6
Conclusion: real estate could have its place in a thematic strategy
Thematic stocks are often equated with “growth stocks”, and rightly so. However, for thematic investors who might, for example, prefer to see “cash flow generation” as a primary attribute, new economy real estate is an interesting consideration.
A data center Real Estate Investment Trust (REIT) will display an income statement with a totally different appearance than a Software-as-a-Service (SAAS) cloud company.
Perhaps in the macro environment of 2022, the correlation between these two is a little higher, but once the fundamentals of the underlying companies can come back to the fore, we believe the two should show significant differences. in terms of risk and return.
Investors looking to allocate to a strategy that would typically have significant exposure to cell towers and data centers may want to take a closer look at the WisdomTree New Economy Real Estate Fund (WTRE).
1 Source: hoyacapital.com/cell-tower-reits
2 Source: statista.com/chart/23194/5g-networks-deployment-world-map/
3 Source: dgtinfra.com/cell-tower-lease-rates-agreements
4 Source: dgtinfra.com/cell-tower-lease-rates-agreements
5 Source: Carol Ryan, “Data Centers Are Unpopular. So much the better for their stocks,” the wall street journal08/30/22.
6 Source: Maurer et al., “Hedges Offer Companies Temporary Relief from Soaring Energy Prices,” the wall street journal03/14/22.
Christopher Gannatti is an employee of WisdomTree UK Limited, a European subsidiary of WisdomTree Asset Management, Inc.’s parent company, WisdomTree Investments, Inc.
As of October 5, 2022, WTRE held 0%, 3.35%, 0%, 0%, 0% in Equinix, Digital Realty Trust, Microsoft, Amazon and Alphabet respectively.
Important risks related to this article
There are risks associated with investing, including possible loss of principal. Investing abroad involves special risks, such as the risk of loss due to currency fluctuations or political or economic uncertainty. Investments in real estate involve additional special risks, such as credit risk, interest rate fluctuations and the effect of varying economic conditions. A Sub-Fund focusing on a single country, a single sector and/or emphasizing investments in smaller companies may experience greater price volatility. The Fund invests in securities included in or representative of its index, regardless of their investment merit, and the Fund does not attempt to outperform its index or take defensive positions in falling markets. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
Christopher Gannatti, CFA, Global Head of Research
Christopher Gannatti started at WisdomTree as a Research Analyst in December 2010, working directly with Jeremy Schwartz, CFA®, Director of Research. In January 2014, he was promoted to Associate Director of Research where he was responsible for leading various groups of analysts and strategists within WisdomTree’s broader research team. In February 2018, Christopher was promoted to Head of Research for Europe, where he will be based in WisdomTree’s London office and will be responsible for all of WisdomTree’s research efforts in the European market, as well as supporting the UCIT platform on a global scale. Christopher came to WisdomTree from Lord Abbett, where he worked for four and a half years as a regional consultant. He received his MBA in Quantitative Finance, Accounting and Economics from NYU’s Stern School of Business in 2010, and he received his BS in Economics from Colgate University in 2006. Christopher holds a Chartered Financial Analyst designation.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.