By Christopher Greenland, Fund Manager
When it comes to real estate, data centres are about as unglamorous as you can get. Yet these large buildings housing servers, data storage, and mile-upon-mile of cabling are already of immense importance to the global economy and property investors.
Only 15 years ago it would have been impossible to imagine our reliance on the smart phone, online shopping, and video conferencing. And streaming the latest TV show, movies and music, wherever and whenever we want, would have been unthinkable back when we were fighting over the latest release at our local Blockbuster store. This remarkable change in how we access retail and entertainment, as well as how we communicate with each other, has meant one thing – a burgeoning need for data and bandwidth.
Because data isn’t something we can see or feel, it’s easy to forget that it exists, and needs to be stored somewhere. With huge amounts of it being generated every single day (90% of data in existence today has been created in the last two years), data centres have become the factories of the 21st century, and the enablers of our digital world. They are the backbone of an increasingly tech-driven global economy, which makes them extremely attractive to investors.
Technology companies are dominating the global economy
A key structural driver behind the need for data centres is the rise of technology companies. As businesses and economies around the world struggled to cope with the global pandemic, four companies dominated the global picture: Apple, Microsoft, Tesla and Amazon. While those companies only make up 10% of the total global stocks within the MSCI Total Return Index, they contributed 45% of the return in 2020. Indeed, Microsoft, Apple, Amazon, Alphabet, Facebook, Alibaba and Tencent are in the top 8 largest companies in the world (by market capitalisation).[i] Tech stocks now account for around a quarter of the S&P 500, while climbing in importance in other global indices.
This rising dominance of technology companies should come as no surprise. In the developed world, tech touches our lives every day, from the time we spend using some sort of screen, to streaming entertainment over the internet and using voice-activated technologies. Even those with an electric car are sent data downloads from the manufacturer to fix problems or make improvements. We’re also seeing significant growth in the so-called Internet of Things (IoT), which means it will soon become commonplace for the utilities in our homes to be connected to the internet, enabling us to control them from anywhere in the world.
As demand grows, one of the reasons tech companies can grow in value so quickly is that they don’t have the cost of many ‘real assets’. Intangible assets (such as the value of the brand, data and patents) are the dominant force, which have an intrinsic value for shareholders, but don’t carry the same cost to a company’s balance sheet as material assets.
An unprecedented rise in data consumption
Another driver behind the demand for data, and therefore data storage, is our increasingly information-intensive and connected world. To put that into context, the number of internet users worldwide has doubled since 2010, while global internet traffic has grown 12-fold, or around 30% per year.[ii] Global internet traffic is expected to continue an exponential trajectory, doubling again between 2020 and 2022.[iii] In 2021, we expect to see double the internet traffic of 2017.
As a result, the digital economy is growing faster than the real economy. In the next few years, we will have more devices per user (smartphones, tablets, laptops, smart TVs, smart appliances), more time spent online per user, improved internet speeds, 5G technology, increased cloud adoption by individuals and businesses, more data-intensive applications, substantial growth in internet users in emerging markets, as well as artificial intelligence, virtual reality, cloud computing and the IoT.
The problem with data centres
But all of this does come at a cost. While data centres are largely hidden from view, they are hugely energy intensive, accounting for about 1% of global electricity demand in 2019. Watching an episode of your favourite series on Netflix uses an enormous amount of energy in getting the HD stream to your living room.
Operators are responding to this challenge by procuring renewable energy sources to power the data centres, as well as using the waste heat for other uses or turning it into electricity. Sweden has demonstrated ingenuity in this area by taking the waste heat from data centres in Stockholm and using it in district heating networks (the data centre operator sells it to the local utility network). The long-term objective is to use data centre waste heat to meet 10% of the city’s heating requirements. Similar projects exist in London, Switzerland and Vancouver, all reducing the need to generate energy from fossil fuels.
The Sanlam view
With such powerful economic drivers, we forecast strong and durable growth in data centres, as well as demand for fibre and 5G infrastructure. Further out, this may include low earth orbit (LEO) satellite constellations, such as the lesser-known Starlink business set up by Elon Musk.
We are long-term investors that seek long-life operational assets aligned to our theme of what we refer to as ‘the pillars of a functioning economy’. We think data centres are just one of many important areas of real assets that are aligned to this theme and an area that has a long-term favourable structural tailwind.
In terms of our own positions we have a few that own, operate and occasionally build data centres as well as fibre assets and telecom towers. The exposure isn’t just limited to the UK or US, our exposure to the sector is global.
From an investment perspective, data centres offer long-term contractual, stable, predictable revenues to the businesses owning and operating them. They have lower credit risk because the largest tenants tend to be big tech names like Microsoft, Amazon Web services, and several fortune 500 companies and investment grade companies. Typically, data centres have ‘sticky’ customers, since they are mission-critical to tenants and the cost of relocating/migrating to another data centre, or building a new one, can be high.
It’s vital that investors don’t write off the property sector amid the decline in need for retail and office space. We must move with the times, and there are always opportunities to be found. Data centres are only going to become more important to the economy of the future. As Bill Gates once said, “The portion of the global economy that doesn’t fit the old model just keeps getting larger.”
Issued and approved by Sanlam Investments. Sanlam Investments is the trading name for our two Financial Conduct Authority (FCA) regulated entities: Sanlam Investments UK Limited (FRN 459237), having its registered office at 24 Monument Street, London, EC3R 8AJ and Sanlam Private Investments (UK) Ltd (FRN 122588) having its registered office at 24 Monument Street, London, EC3R 8AJ.
Past performance is not a guide to future performance.
The opinions are those of the author at the time of publication and are subject to change, without notice, at any time due to changes in market or economic conditions