Risks of investing in data center REITs
Data center REITs have excellent return potential. In fact, leading data center REIT Equinix has produced a staggering 760% total return over the past decade. Return potential like this doesn’t come without risk. Here are a few potential risk factors investors should be aware of:
Interest rate risk
Perhaps the biggest risk factor affecting REIT share prices is interest rates. As an investor, the key thing to know is that rising interest rates are generally bad for REIT prices.
Here’s the simplified explanation of why this is. REITs are income-based assets, and income investors expect a higher return than what they can get from risk-free investments like Treasury securities. When risk-free yields rise (the 10-year Treasury is a good one to keep an eye on), REIT yields tend to rise accordingly. Since price and yield have an inverse relationship, these rising yields lead to lower share prices.
This is always a risk factor with REITs. But it's especially important to be aware of with property subtypes that are expected to grow rapidly.
First, there’s the risk that demand doesn’t grow as fast as anticipated. And second, with so much demand growth in the forecast, it’s reasonable to expect a surge in new construction from competitors trying to take advantage. Supply could end up growing too fast, leading to vacancies and a loss of pricing power.
In some ways, data centers are recession-resistant. For example, consumers don’t stop using their connected devices when the economy does poorly.
However, an economic downturn can cause companies to have less money to spend and pump the brakes on expansion. In short, data centers aren’t a terribly cyclical business, but they aren’t immune to bad economies either.
The five publicly traded data center REITs
There are five REITs traded on U.S. stock exchanges as of May 2019, according to Nareit. Here’s some quick information to help you start your search.