Real Estate Investors Shunning Office Space in Favor of Data Centers

Pandemic Accelerated Pivot Away From the Office

As more employees started working from home during the pandemic, real estate investors took notice. Over the past 22 months, this set has consistently pulled cash out of office properties in favor of data centers containing servers and other equipment. Numbers-wise, Synergy Research Group reports a record $47.1 billion in data center acquisitions for 2021.

In a few such examples, Blackstone (BX) purchased data center-provider QTS Realty Trust (QTS) for $10 billion last summer, while American Tower (AMT) bought fellow data center operator CoreSite in November for billions of dollars. Tracking digital activity further highlights investor interest in data centers. With more workers remote during COVID-19 lockdowns, global internet activity surged by 48% throughout 2020.

Data Center Demand Spiking, But Returns Are Middling

Increasing internet activity has also greatly boosted data storage demands. During 2020, leasing activity was up threefold over 2019, with Microsoft taking up the most space. Estimates say Europe’s four major data center hubs all reached 355 megawatts last year — a 77% increase over levels seen in 2020.

Despite the increased demand, data center stocks have posted only modest returns. In fact, real estate investment trusts specializing in single-family homes, industrial properties, and self-storage facilities have all outperformed US-listed data center REITs. Analysts say this is due to both an oversupply issue and demanding tenants.

Data Center Supply Outpacing Demand, Tenants Drive a Hard Bargain

Analysts caution that while long-term global demand for data centers will remain high, the real estate sector is poised to face some challenges. For one, data center acquisition companies like Equinix (EQIX) and Digital Realty (DLR) face competition from pension funds, existing office owners, and other investors who also favor data centers. This supply glut has notably pushed up vacancy rates in cities like London, Paris, and Amsterdam.

Tech companies that often sign onto leases are also challenging tenants. Namely, their size and marker position provides them with unique leverage, driving down rents. While data shows commercial real estate revenue has posted gains of around 18% per available foot since 2013, the same metric is down 8% for US data centers over the same time period. Real estate investors are clearly enamored with data centers and analysts argue the long-term outlook is strong. But in the meantime, a dramatic oversupply and middling returns pose challenges.

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