Dividend Investing Ideas: Data Center REITs
Dividend investing is a strategy of choosing companies that generate stable cash flows in the long run. Some of Warren Buffett’s rules for investing are related to dividend stocks – he sticks to businesses with long histories and strong competitive advantages. This strategy is often preferred by more conservative investors as dividend stocks perform very well over time, especially when the overall market suffers. The two major approaches to dividend investing are looking for stocks with high dividend yields or high dividend growth. Historically, the dividend yield of S&P 500 is between 2-3%, which provides an enhancement to the total stock returns of a portfolio.
In general dividend stocks are less volatile and thus offer diversification benefits. A further step in this direction is to choose stocks related to alternative asset classes, such as ETFs investing in REITs, some of which have dividend yields exceeding 5%. This comes with pros and cons. ETFs and publicly traded REITs are relatively easy to understand and trade. What is more, REITs must pay out at least 90% of their taxable income as dividend distributions. However, shareholders are paying taxes on dividend income from REITs at their ordinary income tax rate, rather than the qualified dividend tax rate. Even so, the after-tax yield of a well-diversified REIT, VNQ for example, is around twice higher than SPY, which is the most popular ETF for investing in the S&P 500 index.
Some of the types of REITs commonly preferred in recent years are investing in data centers which are offered for wholesale or retail lease. They are secured facilities that house servers, computer and telecommunication systems and associated components. The main purpose of data centers is to centralize an organization’s most critical IT operations and equipment, and to guarantee secure and reliable storage, as well as off-site backup, of its data. Due to increasing data traffic there is a growing demand for data storage. I believe data centers deserve the investor interest lately and should be considered by everyone looking to diversify their retirement portfolio – either as directly owning their stock or as a part of an ETF investing in REITs.
Data centers offer the opportunity for exposure to a combination between real estate and the technology sector, specifically taking advantage of the expanding cloud computing industry and the need for storage of big data, which is forecast to continue to grow. It is worth mentioning that some of the large companies that are using the services and leasing space from data centers are IBM, Amazon, Verizon, Cisco, AT&T, Microsoft, Oracle, Google.
Equinix Inc. (EQIX) is the largest of the data centers by market cap, part of S&P 500 and was upgraded to BUY last week by Stifel. Its performance ytd is +17.5% and y-o-y +29.9%. The company is servicing a broad range of industries, such as advertising, cloud service providers, government, gaming, mobile, healthcare, e-commerce, etc. Apart from cloud infrastructure solutions, another of Equinix’s solutions, practically used by every company or institution, is disaster recovery and business continuity. The other smaller players in the market are Digital Realty Trust, CyrusOne, QTS Realty Trust, DuPont Fabros Technology and CoreSite Realty.
Direct investment in data center stocks may seem a bit complex for not sophisticated or tech-savvy investors, but an encouraging point is that in August 2016, S&P Dow Jones Indices and MSCI Inc., a leading provider of investment decision support tools worldwide, announced to move out Equity REITs from the Financial sector and they are now promoted under their own sector code. This is a recognition for the sector (as a side note, Mortgage REITs remain under Financial sector) and acknowledging its importance to the global economy and the portfolio building process. When looking into indirect ways to get exposure to data center REITs we may naturally look into the ETF database – ETFdb.com. The largest REIT by assets under management is Vanguard REIT ETF, VNQ. It is currently traded at P/E ratio of 29.2 and offers a quarterly dividend of $0.59 per share or 4.36% annua
l dividend yield. More interestingly, analyzing its holdings we can see that after its largest holding – the shopping mall operator Simon Property Group Inc., SPG (6.38%), follows Equinix with a share of 3.81%. EQIX is currently traded at $417.70 and recently declared a quarterly cash dividend of $2.00 per share.
In order to summarize, data centers might be a good option for indirect bet on technology, while at the same time enhancing and diversifying your dividend stock portfolio.
Disclosure: The article does not represent an investment advice and I don’t own directly any of the stocks mentioned in the article.