Over the last few years, the cloud has been a prominent buzzword and investment theme. The National Institute of Standards and Technology defines cloud computing as “...a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction.” In other words, the cloud is a remote network of servers that perform computing functions historically conducted on a personal computer or local server.
Cloud computing and data centers are often mentioned together because the servers that provide the computing power to the cloud are generally housed in data centers that have very specific capabilities, particularly with regard to power and cooling (you can’t just throw hundreds of servers into a big warehouse and flip a switch). In recent years, enterprises have grown increasingly comfortable with the level of security, cost, and flexibility offered by cloud data centers. This has led to an explosion in traffic, creating a need for more data center capacity (Exhibit 1).
Exhibit 1: Cloud Data Center Traffic Growth
Source: Cisco Global Cloud Index, 2014-2019
Most would not consider that the cloud is also having an effect on real estate companies. However, as demand for cloud computing and cloud data centers has risen, several publicly-traded data center Real Estate Investment Trusts (REITs) that provide turnkey solutions have emerged as prime beneficiaries of this trend. Not surprisingly, cloud providers have been the driving force behind the accelerating leasing volumes reported in recent quarters by five data center REITs (Exhibit 2).
Exhibit 2: Leasing Volume of Data Center REITs
Source: Jefferies, company reports
This acceleration in leasing volumes has caused investors to adopt a more bullish outlook for the earnings power of data center REITs, leading to substantial outperformance relative to the MSCI US REIT Index in recent months (Exhibit 3). Outperformance may continue as analysts are forecasting that the percentage of enterprise workloads in the cloud will increase from 20-25% to 30-40% over the next several years, capital expenditures by cloud providers has accelerated, and several cloud providers have dozens of RFPs outstanding for several hundred megawatts of data center capacity. As one data center REIT CEO described it on a recent conference call, “We are in the very early stages of cloud right now. I’d say we’re in the first inning.”
Exhibit 3: Relative Strength of Data Center REITS vs. MSCI US REIT Index
Source: Factset, Driehaus
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