What Tech Wreck? Data Center Stocks Offer Shelter in a Stormy Market

Extreme volatility in publicly traded equity markets reached a crescendo on Wednesday, as the Dow 30 and S&P 500 gave back remaining 2018 gains, the Nasdaq hit even harder, sliding into correction territory.

Semiconductors were the hardest hit. But cloud providers (including SaaS) and the rest of the tech-heavy on Nasdaq were also crushed.

After a rough session Tuesday came a brutal Wednesday sell-off, and one of the few places to hide were REITs, including the six data center REITs. Never mind the carnage for their biggest customers – the hyperscale cloud platforms – and key equipment suppliers.

A diversified equities portfolio that included REITs, blue-chip consumer stables, utilities, and dividend payers like Verizon has been the only way to weather the storm.

Microsoft announced solid results Wednesday, but its shares were sold off with the rest of the FAANG gang. News of pipe bombs mailed to some of the most prominent Democrats Trump loves to hate added more fuel to the selling fire.

US REITs were viewed a "risk-off" alternative to multinationals that are exposed to a slowing China economy and an increasingly vexing tariff stand-off between the two largest global economies. Mr. Market hates uncertainty, and investors appreciate that. The tariff kerfuffle has become a huge wildcard for many companies and sectors going forward.

Related:Why the Selloff Can Be a Data Center Stocks Buying Opportunity

Tale of the Tape

While the two are inseparable, the business of leasing data center space, power, and connectivity is fundamentally different from the business of selling computing gear and cloud services.

Investor Edge

Data center REITs lease space to credit-worthy tenants on a long-term basis. Typical retail colocation leases last two to three years, historically aligned with the server refresh cycle. Wholesale leases – the kinds hyperscale platforms do – can be anywhere from five to 10 years, and sometimes longer. That usually ensures that the REITs deliver predictable dividends to shareholders.

Investment-grade tenants – the likes of Amazon, Microsoft, Google, IBM, and Oracle – help insulate data center operators from the uncertainty associated with a more hawkish Federal Reserve, global GDP growth concerns, the tariff spat (and its impact on global supply chains), consumer confidence, or new home sales.

The same can be said for traditional REIT sectors, such as single-tenant freestanding net-lease landlords, office, and industrial. In fact, there can be similarities between a Class-A industrial building in the right location and a data center powered shell.

Most REIT leases contain contractual rent bumps, which enable landlords to grow cash available for distribution and raise dividends over time. This contrasts with bonds or other fixed-income securities unable to deliver increasing returns to investors in a rising-rate environment.

Additionally, high-quality US commercial real estate assets are a classic hedge against inflation. As the prices of land, labor, and materials rise (along with interest rates on construction loans), existing portfolios of well-located assets will become more valuable.

Bottom Line: NAREIT research has shown that adding a 10 to 15 percent allocation of REITs to a portfolio of stocks, bonds, cash, and alternative investments like precious metals has historically generated higher risk-adjusted returns.

The tailwinds that are driving the data center sector are not leveraged to consumer spending, GDP growth, employment, or home sales. Instead, cloud computing, 5G and wireless data, social media, content and media, fintech, AI and big data, IT outsourcing, enterprise digital transformation, and hybrid IT deployments are all driving demand.

Most investors look to data center REITs for growth. However, high-quality REITs can also provide a measure of safety when other asset classes are being sold-off indiscriminately.