Colocation services giant Equinix will start 2015 as a real estate investment trust. The company’s board of directors unanimously approved the conversion earlier this month, and the company expects to get approval by the end of 2014 or early 2015. It will start operating as a REIT on January 1, 2015.
A REIT is a corporation that pools capital of many investors to purchase and manage income property. The structure was introduced in 1960 as a way to offer small investors a way to invest in large-scale commercial real estate through securities. Data centers are unique real estate, but real estate nonetheless, so many of the large providers have either converted or contemplated conversion.
In a REIT, income comes from rent of the properties, and REITs are legally required to distribute 90 percent of their taxable income to investors. It means Equinix will have regular distributions of its earnings. In addition to boosting investor interest, analysts say a REIT conversion would result in lower taxes for Equinix.
"Equinix’s REIT conversion equates to substantial tax savings, which could potentially be reinvested back into the business in the form of additional capital to further strengthen its global position in new and existing markets," said Jabez Tan, senior analyst at Structure Research. "Converting to REIT status also adds more transparency and visibility to the broader colocation market with data center asset disclosures."
The decision isn’t as cut-and-dry as it looks on paper, however. There are several factors that need to be weighed in making the conversion.
"Due to sizable initial costs associated with REIT conversions, a certain level of stability in the business is required before pursuing such a move," said Tan. "We expect to see more such REIT conversions, as the data center colocation market continues its current trajectory of growth and maturity.”
Equinix’s journey to become a REIT began a few years ago. When its intentions became official, shares surged in tow. When CFO Keith Taylor announced the company was exploring the merits on its fourth quarter earnings call in 2011, he said the company was analyzing various structures, including alternative financing, capital, and tax strategies in a bid to maximize long-term shareholder value.
"I it as a tax strategy, not a business model," said Compass Data Centers CEO Chris Crosby. "It makes a lot of sense for them. This was not a rash decision; they’ve been studying for a while. The cash they can generate is much better from a tax perspective. It’s the right structure for the right time."
Crosby was formerly with the biggest data center REIT called Digital Realty Trust. Since leaving the company, he has grown Dallas-based Compass from upstart to serious player in just a few years. Crosby said the REIT model is good for stabilized assets, but there's a question mark if the capital is going towards growth.
The REIT Class
Several of the major data center players are structured as REITs, including Digital Realty, DuPont Fabros, CoreSite Realty, QTS Realty Trust and CyrusOne. Iron Mountain recently joined the REIT fray after announcing its intentions around the same time as Equinix. Windstream Communications is planning on splitting the company in two, creating a separate operating business for REIT assets and one for networking assets.
The IRS put data center REIT conversion on hold in 2013 because of the gray areas of data center revenue from services and the colocation leasing model. Data centers are a unique form of real estate in terms of construction and business model, so there was a question as to whether they qualified.
Data centers are big business. The colocation market was pegged as $25 billion by 451 Research, with half the revenue coming from the top 60 providers. Equinix is a major player in both primary domestic and international markets.