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18 | THE DATA CENTER JOURNAL www.datacenterjournal.com able earnings make data center REITs an attractive category for real-estate investors." INTEREST RATES AND FEDERAL RESERVE POLICY Interest rates are a major factor in real estate. Heavily dependent on Federal Reserve policy, mortgage rates can be the difference between a relatively affordable property and an unaffordable one. In aggregate, low interest rates mean money is inexpen- sive, thereby driving riskier invest- ments—particularly since banks offer little or no return on cash. e result is a growing market in some sectors, at least in terms of asset prices. But with the central bank having kept interest rates so low for so long (the effective federal funds rate was essentially 0% from late 2008 to late 2015, and it still has yet to hit even 1%), normalization to anything near historical levels (the effective federal funds rate was around 5% for most of the 1990s) could be horrific for some markets. e ques- tion in this case is whether Federal Reserve policy can and will affect data center REITs; the central bank has promised to steadily raise inter- est rates, although it has yet to follow through on its own hype. "Rising interest rates typically put downward pressure on REIT stocks because the industry has some 'bond- like' characteristics given the dividend aspect of the model," said Morefield. "REITs, however, have over the past few decades generally outperformed the broader stock-market indices in total shareholder return. In addition, the high-growth profile of the data center REITs should provide a further hedge against a rising-interest-rate environment relative to the broader REIT market. Although rising rates will put pressure on interest expense to fund the capital requirements, that increase will be muted by the strong cash-flow growth from data centers as they lease up and are stabilized." So, despite the clear exposure of data center REITs to influence by Federal Reserve policy, the data center sector exhibits underlying strength that other sectors may not. e difficulty, however, is de- termining how much of the demand in a sector is due to misallocation of resources. Because monetary policy affects the entire economy (money is "cheap"), the industries with the greatest malinvestment can be tough to identify. Low interest rates encour- age investment and spending (par- ticularly if inflation is relatively high) that might not have taken place given higher rates. One can make a good case that IT is so integral to business today that it's not a locus of malinvest- ment, but such a rationalization can only be tested by an actual return to higher (i.e., historically normal) inter- est rates. For example, long-time inves- tors—particularly those in real es- tate—will keenly remember the hous- ing bust during the Great Recession. Although a few individuals foresaw the coming trouble ahead of time, citing extensive subprime lending and other factors that pushed up demand and thus prices, many simply believed that real estate (specifically, housing) by nature always increases in value over time. Housing and commercial real estate are obviously different and involve different dynamics, but the specter of the housing bust remains. For the data center market, Mo- refield said, "We are seeing a healthy balance between demand and supply in our key markets. To the extent the data center REITs have a 'cycle' similar to other real-estate product types, we believe we are in the early stages of what will be a long-term growth trend. Further, we do not see any correlation between the residential- real-estate market and data centers." Moreover, she believes that REITs in the data center sector have more po- tential for development than those in more-established sectors. "In baseball terms, most REIT product types are in the eighth or ninth innings, while data center REITs are in the second or third innings; it's a great place to be as a company and for a savvy investor." CONCLUSIONS Data center REITs are a way for investors to get in on a market with growing demand for services. e present business (and consumer) hunger for more storage, more net- work bandwidth and more compute capability bodes well for data center providers, and that means REITs for this sector have at least one ostensibly fundamental strength. And because a data center REIT share is much like a stock, it makes this market easily accessible even to small investors. One concern, however, is Federal Reserve policy—particularly with regard to interest rates. Higher rates or an economic recession would likely hit data center REITs to some extent, but the question is how these invest- ments would perform compared with everything else. Business goes on even during a recession, and the demand for cloud and colocation may help buoy the data center industry and, therefore, data center REITs. Such conjectures are naturally speculative, however. At least for the short term, if not the long term, data center REITs are one option for investors looking to buy something relatively solid, com- bining the benefits of real estate with the ease and liquidity of stocks. n