Market Commentary | October 18, 2024
Growth
Now that the Fed has at last started reducing interest rates, our attention can more singly be focused on growth opportunities in today’s economy. The obvious, and most talked about trend is artificial intelligence. AI has potential real estate applications to make property maintenance and leasing more efficient, but at present, the flow of capital is to the development of a new generation of data centers that AI will require.
Over the years we have successfully located and invested in favorably priced data center REITs, but ultimately those companies were bought out for premium prices or bid up to uncomfortably high valuations. With remaining data center REITs trading at a consensus AFFO multiple north of 26x, we don’t perceive the shares as a compelling opportunity, but that hasn’t deterred other investors from throwing $billions at data center development. On October 17th, DataBank announced they had raised $2B in equity to joint venture with Digital Bridge (DBRG) to develop facilities in Dallas, Northern Virginia, and Atlanta. The Phoenix Business Journal announced that Amazon (AMZN) has paid $277MM for 220 acres near Phoenix to build a new data center campus.
We agree with the market’s perspective that Artificial Intelligence is a world-changing investment opportunity and we have always maintained that “REITs Touch Every Economic Sector”, but price is important. With that consideration, we are looking further into the AI vertical to attach the growth at more favorable prices; we are buying the producers of electricity that will power the rapidly growing fleet of data centers.
In responsible address of climate change, large tech companies (owners and developers of data centers) have pledged to significantly reduce their carbon emissions footprint. The AI GPUs that power those centers consume even more electricity than their predecessors, so deployment of Artificial Intelligence products and services makes emissions reduction an even more daunting task. On October 7th, Microsoft (MSFT) signed a deal with Constellation Energy (CEG) to restart their Three Mile Island nuclear power unit. On October 16th, Dominion Energy (D) announced an agreement with Amazon to develop Small Modular Reactors (SMRs) to meet AMZN’s growing clean energy needs. Amazon’s new Phoenix campus will likely be powered by Pinnacle West Capital’s (PNW) nuclear and renewable energy production.
The new supply of data centers is creating a huge new demand for clean, carbon-free, electricity. In addition to CEG, D, and PNW, we have identified and analyzed opportunities in other renewable energy producers like HA Sustainable Infrastructure (HASI), Clearway Energy (CWEN.A), and NextEra Energy Partners (NEP). These companies each forecast a long growth runway, and the AI buzz has not yet been fully priced into energy producers allowing us to buy these at high going in cashflow yields.
We remain dedicated REIT investors, but to seize opportunity we sometimes have to look REIT adjacent.
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