Data center real estate investment trusts (REITs) were some of the best-performing stocks in the real estate sector in 2020. Despite the overall real estate sector declining by about 5% last year, judging by the performance of the Vanguard Real Estate ETF (NYSEMKT: VNQ), leading data center REITs Equinix (NASDAQ: EQIX) and Digital Realty Trust (NYSE: DLR) delivered total returns of 24.2% and 20.4%, respectively.
There's a good reason for this. As the COVID-19 pandemic hit, many types of commercial real estate were forced to shut down or operate at a fraction of normal business levels. On the other hand, with millions of people working from home, streaming more content than ever, and using their connected devices at unprecedented levels, the volume of data flowing around the world soared. And this was great for data centers.
But that was then. Now that COVID-19 vaccines have started to roll out and people are seeing light at the end of the tunnel, data centers have underperformed for the first couple months of 2021. However, they could still be excellent long-term investments. Here are three things data center investors should know now that 2021 is well underway.
The long-term catalysts for data center growth are positive
To be sure, we could see the pandemic-related spike in data taper off in 2021. However, the long-term catalysts for the data center industry point to years, if not decades, of steady demand for new facilities to house servers and other networking equipment in secure, reliable environments.
For starters, 5G technology has started to roll out, but it will take years for the infrastructure upgrades necessary for nationwide coverage in the United States. And it will take even longer in other parts of the world (remember, most data center companies are international).
Plus, the number of connected devices is massive and only expected to grow in the years ahead. This is especially true for data-heavy technologies like artificial intelligence (AI), which is expected to grow from a $11 billion market in 2019 to $90 billion by 2025. Augmented reality and virtual reality are expected to approach more than $100 billion in market size combined by 2025.
The point is that while their stocks may have cooled off for the time being, the long-term investment case for data centers is intact.
There's another data center operator set to go public in 2021
When it comes to colocation data center providers, Equinix and Digital Realty Trust are the two largest players in the space, by far. But we recently learned that Cyxtera, the third-largest provider, is getting set to go public through a merger with special purpose acquisition company (SPAC) Starboard Value Acquisition (NYSE: SVAC).
Now, Cyxtera is a significantly smaller company than either of the two leaders. It operates 61 data centers with about 1.9 million sellable square feet and is being valued at about $3.4 billion. It originated from a separation of CenturyLink's data center assets. For reference, Equinix's market cap is about $58 billion. However, if you're looking to invest in the retail colocation data center space and want an up-and-coming player, you now have another option.
2021 could be a so-so year for data center REITs
As a final thought: As the world gradually returns to normal, it's entirely possible that so-called "reopening stocks" will outperform, while the stocks that benefited in the stay-at-home economy of 2020 (like data centers) could underperform.
Now, I'm not saying I think data centers will plunge in 2021 or anything like that. These are still solid, well-run companies with steady, predictable cash flow and lots of future growth potential. However, if you're going to add data center stocks to your portfolio in 2021, you should be planning to hold them for several years at a minimum. There's no way to predict how data center REITs might perform this year, but long-term investors in high-quality companies should do quite well over the long run.