Many investors find real estate investment trusts (REITs) to be a solid investment choice. These companies can provide passive income and long-term growth, without the typical requirements of owning property. One subset of this real estate investment sector has led the charge above others in recent years, and that’s because demand for data centers is at an all-time high. As a result, REITs that own them are seeing unprecedented investment growth. For this reason, data center REITs may play a valuable role in your investment portfolio. You may want to work with a financial advisor to plan how your portfolio could include them.
What Is a Data Center REIT?
A real estate investment trust, or REIT, is a company that owns a variety of different real estate assets. Investors can buy into these REITs by purchasing shares (similar to a mutual fund), which allows them to benefit when the assets held by the REIT earn a profit.
REITs can be a simple way for investors to buy into real estate without needing large sums of cash or even the time that managing a property requires. The company researches, buys, develops, manages and even maintains the real estate investments that it owns, while investors provide their share of the capital. Rather than investors finding tenants, collecting rent or paying property taxes each year, the REIT handles it all.
When the REIT recognizes a profit – primarily through tenant rent payments – investors share the spoils. Not only can share prices increase, but REITs are also required by the IRS to pay out at least 90% of their taxable income to investors each year. These payments (in the form of dividends) can be a great source of passive income.
Data center REITs in particular invest in facilities that store servers and other data-based equipment. In order to be both secure and reliable for the companies that rely on them, these data centers are required to have dependable power sources, top-notch security and state-of-the-art cooling equipment.
While data centers are relatively newer, their projected growth is exponential. Nearly every company and industry relies on data storage, from cloud-based software to internet hosting and even artificial intelligence (AI) platforms. In fact, data center REITs were the highest-performing real estate investment trust sector in 2020, and show no signs of slowing.
Advantages of Data Center REITs
So, should data center REITs make it into your investment portfolio? The answer to that question depends on your goals, timeline and risk profile. It also depends on what kind of asset allocation you have decided on for your investment portfolio. But to help decide if data center REITs are a good fit for you, here are a few reasons to consider buying shares.
Promising Past Performance: In 2020, data center REITs had an incredible year – their second-best on record, in fact. They were the highest-performing type of real estate investment trust.
Continued Explosive Growth Seems Likely: With the continued growth of everything from AI to cloud storage, remote working trends, self-driving cars and a tech-driven society, the demand for reliable data centers is likely to increase. For investors, this could mean sustained appreciation in the years to come.
Providing Passive Income: Like all REITs, data center real estate investment trusts are required to pay dividends to investors when earning a profit. These dividends can be reinvested or put toward other financial goals, such as saving or paying monthly expenses.
Unique Portfolio Diversification: Savvy investors know that you should never put all of your eggs in one basket. By buying into REITs, investors can diversify without managing the properties themselves or putting up as much capital. With data center REITs in particular, investors are diversifying within a sector that is likely to grow in demand.
Risks of Data Center REITs
No investment is without risk, and data center REITs are no exception. Here are some things to keep in mind.
Limited Performance History: Though they are the current “top dog” in the REIT world, data center REITs are relatively new. These companies began popping up in the early 2000s. In turn, we don’t have as much long-term data to study as other sectors.
Market Rates Can Affect Value: Typically, REITs and Treasury yields have an inverse relationship; as interest rates rise, REIT shares tend to decline. While this isn’t always the case, it’s something to keep in mind as market rates shift.
Oversupply Is Possibly an Issue: All types of real estate are subject to the effects of a flooded market. Sure, data center REIT demand is high now. But, if more data centers are around than we need in the future – either due to market trends or higher efficiency – an oversupply of available property could mean investment losses.
Bottom Line
Data center REITs are one of the highest-performing REIT sectors of 2021. Additionally, they continue to show promise in our increasingly digital world. These companies – which own and manage the buildings necessary for servers and data storage – can help investors diversify their portfolios and earn dividend income in the process. Because of their performance and likely demand in the future, data center REITs may help investors hedge risk against market downturns and even inflation.
Investing Tips
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Not sure whether data center REITs are the right investment for you and your retirement goals? Consider working with a financial advisor. Luckily, finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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One way to make sure you’re not over-investing or under-investing in REITs is to use a free asset allocation calculator. This will help to ensure that your portfolio isn’t overly reliant on a specific area of the market.
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