Jonathan Peterson of Jefferies expects data center real estate investment trusts to thrive for the foreseeable future, opposing Jim Chanos (Trades, Portfolio)' argument against the industry.
According to Peterson, "Operators are able to increase base rents annually and should continue to benefit from the post-pandemic occupancy recovery."
In contrast, Chanos, the legendary short seller and founder of Kynikos Associates, argued against data center REITs in a recent interview with the Financial Times. He said, "The story is that although the cloud is growing, the cloud is their enemy, not their business. Value is accruing to the cloud companies, not the bricks-and-mortar legacy data centers."
Peterson and Chanos each have valid arguments, so there is also a chance that both could be correct.
An interesting juxtaposition
First, Peterson centers his argument on an income-based approach. REITs are usually income-based investment opportunities as they pay out most of their earnings in dividends to investors.
Based on the data center space, it is likely that most REITs will have strong tenants as it includes tenants that occupy cloud-based businesses. The cloud industry is forecasted to grow at a compound annual rate of 14.9% until 2031. Cloud businesses are considered secular in nature, meaning they will likely be able to pull through a recession by sustaining their earnings.
Source: Grandview Research.
Chanos' argument evolves around price discovery, which is inextricably linked to the general commercial real estate market. Thus, data center properties will not garner value because of their underlying business activities.
With mortgage rates skyrocketing past 5% and geopolitical risk persisting, we are likely to see broad-based real estate values stagnate for the foreseeable future. Furthermore, real estate prices do not exhibit price momentum as many stocks do, meaning they could see an abrupt drop if a recession comes to fruition.
Source: Statista; Freddie Mac.
Two data center REITs to consider
For investors who support Peterson's bull case instead of Chanos' bearish argument, the following REITs might be suitable investment options.
First up is Equinix Inc. (EQIX, Financial), a leading digital infrastructure company focusing on connectivity services.
Equinix's portfolio comprises nearly 250 data center facilities dispersed across four continents.
This REIT provides a dividend yield of 1.91% and has a price-to-adjusted funds from operations ratio of 23.40.
Another potential opportunity is CyrusOne Inc. (CONE, Financial), which focuses on carrier-neutral data centers and acts as a provider of colocation and peering services.
The REIT contains approximately 50 data centers globally, with a presence in the U.S., the U.K. and Singapore.
CyrusOne is a price momentum pure-play, trading above its 10-, 50-, 100- and 200-day moving averages.
Concluding thoughts
Chanos and Peterson both have valid viewpoints. I believe data center REITs will sustain their income and dividend payments. Additionally, for the time being, there is inconclusive evidence that the real estate sector will crash.
