REITs Industry Update | April 17, 2014
On April 15, 2014, the Cantor REIT team hosted a conference call with Mr. Bryan Loewen, Senior Managing Director and Leader of the Newmark Grubb Knight Frank’s Data Center Consulting Group, a Cantor Fitzgerald affiliate. Topics of discussion included high frequency trading, tenant leasing dynamics, market fundamentals, development activity, and the transaction markets. Overall, little has changed within the data center landscape year to date; demand levels remain healthy, yet ample supply continues to create a headwind to overall rental rate improvement. We continue to underwrite a stable operating landscape in the data center sub-sector, though the rapid maturation of the industry continues to compress yields to levels that are more in-line with other REIT property types. Our top picks with the space remain Digital Realty Trust (NYSE: DLR; BUY) and DuPont Fabros Technology (NYSE: DFT; BUY).
- High frequency trading (HFT). Given the recent focus on potential regulation of high frequency trading, our first topic was the potential impact to demand. The majority of exposure resides within retail, however, and by nature is located primarily in New York and Chicago. Mr. Loewen does not believe potential regulation poses a substantial macro threat at this time, with only a few spot concerns. Furthermore, he believes that any space returned to market could be absorbed by other tenant types with similar technology / proximity requirements, such as animation studios and energy-related applications. We also believe that the low latency space occupied by HFT tenants should be desirable to other trading-oriented tenants, given location, speed, and inter-connectivity.
- Broad fundamentals unchanged. Mr. Loewen has seen little change with regard to fundamentals year-to-date, as demand remains “adequate,” the pace of leasing strong, and the level of supply a continued rental rate headwind. He is seeing activity from both retail and wholesale tenants, with Fortune 5000 tenants remaining amongst the most active. Mr. Loewen also noted that the federal government has some new requirements in the market today and that cloud and content providers should also continue to absorb additional space. In aggregate, the ongoing advancements in technology have resulted in the increased utilization of space, though Mr. Loewen’s view that “demand growth will outpace technological improvements” remains unchanged.
- Sublease overhang. The threat of sublease space in the market has been an investor concern for some time and was recently amplified by the addition of even more space to the Northern Virginia market. Today, the majority of sublease availability is in Northern California and Northern Virginia, primarily the result of tenants opting to build their own centers. While this addition of supply to the market has hindered rental rate growth, Mr. Loewen highlights that the sublease space is a very tough sell to prospective tenants, given short lease terms (for example), and is often not leased as a result. He expects that the majority of discussions involve the landlord, with the potential for early termination and termination fees. Mr. Loewen mentioned that he does expect to see additional sublease space come to the market in coming months – likely to be negative near-term catalysts.