Datacenter Darlings: Wells Fargo Likes These Two REITs

These are tough times for data-center REITs, as the tech and real estate sectors are suffering. Here’s 2 investment ideas from Wells Fargo.

These are tough times for real estate investment trusts that focus on data centers, as both the technology and real estate sectors are suffering.

Stocks in those two sectors have rebounded a bit in the past few weeks, but data-center REITs have participated in the recovery for only the past few days.

Two of the top data-center REITs have seen their stocks fall: Digital Realty Trust  (DLR) – Get Digital Realty Trust Inc. Report is off 28% this year while Equinix  (EQIX) – Get Equinix Inc. Report has slid 23%. Those compare with a 17% spill for the S&P 500.

But heading into second-quarter earnings reports – July 27 for Equinix and July 28 for Digital Realty – things are looking up, Wells Fargo analysts wrote in a commentary.

“We remain overweight on both EQIX and DLR,” they said. As for their earnings, “we expect demand momentum and top-line growth to shine through, despite headwinds from [the strong dollar].”

‘Robust’ Leasing Volume

The analysts’ recent market checks indicate “leasing volumes remain very robust, with a notable pickup in enterprise activity,” they said. “And pricing growth has sustained, with new lease prices up 10% to 15% (or more) versus last year.”

The analysts are trimming their estimates slightly for funds from operations and adjusted FFO in fiscal 2022 and 2023.

But “the changes are almost entirely due to the stronger dollar, with constant-currency [adjusted FFO] growth still poised to accelerate to the high single-digit range next year,” the analysts said.

“We maintain a slight preference for DLR in the near term, but believe investors should be long both names, particularly at current valuation levels, where we see more limited downside risk.”

Digital Realty has a trailing price-earnings multiple of 26.3, compared with a five-year average of 83.78, according to Morningstar. For Equinix, those numbers are 120.9 and 134.2.

Hyperscalers and Enterprise

The strong demand for cloud-computing demand will help the two REITs, the analysts said. “We continue to hear about large volumes of activity from the hyperscalers [large cloud hosts], with AWS [Amazon  (AMZN) – Get Inc. Report Web Services] and Google  (GOOGL) – Get Alphabet Inc. Report (who historically have self-built) in the market for large turnkey deals,” they said.

“Due to supply-chain constraints and long lead times for power, customers are increasingly securing capacity two to three years ahead of commencement dates.”

Growing cloud use by large companies also will boost the REITs, Wells Fargo analysts said. 

“Our checks on enterprise demand were even more encouraging, as several private operators told us they had record signings in the second quarter, with the size of enterprise deals also scaling.”

Both DLR and EQIX are likely to speak a lot about strength in the enterprise segment in their earnings presentations, the analysts said. Enterprise has more favorable pricing and return characteristics than hyperscale, they said

Turning to the increase in lease prices, they “should continue to rise based on record-low vacancy rates in major global markets and construction pipelines that are heavily pre-leased (60% to 70% or more),” the analysts said. 

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Union Capital Financial Group Ltd, registered in the British Virgin Islands, does not provide investment services inside the United States. The company only provides consulting, advisory and educational services.