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REITs are obliged to distribute at least 90% of their taxable income to their shareholders in the form of dividends. Therefore, they are great candidates for the portfolios of income-oriented investors. This is especially true in the current investing environment, as many REITs have become exceptionally cheaply valued due to their sell-off since the surge of inflation early last year. In this article, we will discuss the prospects of three data center REITs, which have strong business models in place and are attractively valued right now, namely American Tower (AMT), Blackstone Group (BX), and KKR & Co. (KKR).
 

American Tower

American Tower was founded in 1995 and is one of the largest multi-national REITs in the world. The company specializes in owning, operating, and developing multitenant communications real estate, with a portfolio of more than 220,000 communications sites in the U.S. and in international markets.

American Tower enjoys a significant competitive advantage thanks to its dominant business position in the U.S. market. Not only is the REIT entrenched in the space, but switching costs for its customers after the equipment has been installed are excessive. In other words, the customers of American Tower are highly dependent on the REIT. In addition, American Tower enjoys great economies of scale, as the cost of adding new tenants to an existing tower is almost negligible.

Thanks to the tailwind from the secular growth of the demand for data centers, American Tower has grown its earnings per share by 12.4% per year on average over the last nine years. The REIT benefits from the ramp-up of 5G in the U.S. and Europe and the expansion of 4G in earlier-stage markets. However, it has remarkably decelerated in the last three quarters and thus it is likely to incur a marginal decrease in its funds from operations (FFO) per unit this year. If this occurs, it will mark the first decrease in FFO per unit after 7 consecutive years of growth.

The stagnation in the bottom line has resulted primarily from a steep increase in the interest expense of the REIT, which has resulted from the multi-year high-interest rates prevailing right now. Due to this headwind, the stock has plunged 29% in the last 12 months and thus it is offering a nearly 10-year high dividend yield of 3.3%.

Given the determination of the Fed to restore inflation to its long-term target of 2%, we expect inflation to subside and interest rates to normalize in the upcoming years. When that happens, the stock of American Tower is likely to recover strongly. In the meantime, the dividend of the REIT appears safe thanks to a healthy payout ratio of 64% and the decent growth prospects of the business.
 

Blackstone Group

Blackstone Group, which was founded in 1985 by Peter Peterson and Stephen Schwarzman (still CEO), is one of the largest investment firms in the world. The company has a market capitalization of $104 billion and holds $991.3 billion in assets under management (AUM), operating in Private Equity (29% of AUM), Real Estate (33%), Credit (29%), and Hedge Fund Solutions (9%).

Blackstone has grown its earnings per share by 5.9% per year on average over the last nine years. However, it has a volatile performance record and it has proved somewhat vulnerable to recessions. In the Great Recession, the company posted a loss per unit of -$1.03 and cut its dividend by 50%, from $1.20 to $0.60. It is thus unsuitable for investors who are afraid that a severe recession may show up in the upcoming years.

On the other hand, Blackstone proved resilient throughout the coronavirus crisis, primarily thanks to the unprecedented fiscal stimulus packages offered by governments in response to the crisis. As a result, the company nearly doubled its distributable earnings per unit, from $2.65 in 2020 to an all-time high of $5.17 in 2022.

Moreover, the stock has declined 28% in the last 12 months, primarily due to the impact of multi-year high interest rates on the valuation of the entire REIT sector. Blackstone is currently offering a nearly 5-year high dividend yield of 4.6%, with a reasonable payout ratio of 73%. In the absence of a severe downturn, the dividend is not likely to be significantly reduced. Moreover, whenever interest rates begin to normalize, the stock of Blackstone is likely to highly reward investors.
 

KKR & Co.

KKR & Co is a global investment company, which was founded in 1976 and has a market capitalization of $46 billion. The company has over 1500 employees across 16 countries and holds assets under management (AUM) of $496 billion.

Scale and reputation carry more weight within the asset management industry than in a traditional business. KKR has a stellar reputation and thus it has grown significantly its business in international markets, such as Asia. About a year ago, KKR completed the acquisition of KJR Management, one of the largest real estate asset managers in Japan, for ~$1.8 billion.

KKR has grown at an impressive rate since 2004 compared to its peers. While the assets under management in the alternative asset market have grown at an average annual rate of 11%, KKR has grown its assets under management by 22% per year on average. In addition, as the business continues to scale, the management fees have grown from $732 million to $2.1 billion, representing an 11% average annual growth rate. Over the last five years, after-tax distributable earnings have grown by 16.9% per year on average.

On the other hand, investors should be aware that KKR has exhibited a highly volatile business performance and is offering a lackluster dividend yield of 1.3%. This yield is much lower than the 4.0% median dividend yield of the REIT sector. Overall, KKR has promising growth prospects in the long run but investors should be aware of the volatile business performance of this REIT.
 

Final Thoughts

Data center REITs have stronger business models than most REITs in general. In addition, most data center REITs have incurred a sell-off since early last year, in tandem with the entire REIT sector, and hence they have become attractive from a long-term perspective. The above three REITs are likely to highly reward patient investors whenever interest rates begin to normalize.

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