The Best Way To Invest In Data Centers

The AI revolution has created a lot of interest in data centers, and as a result, many of you often ask me:

What are the best data center REITs to buy today?

We agree that this could be a huge long-term opportunity, but the problem is that this is mostly priced in with most data center REITs trading at fairly expensive valuations.

Note also that data center REITs have historically excluded at least a portion of their recurrent maintenance capex from their AFFO calculations, disguising it as expansion capex instead, resulting in even greater valuations when adjusted for that. Some REITs are more conservative than others, but there is skepticism about all of them, and it is very hard from the outside to assess how much of it should really be considered maintenance vs. expansion capex.

Moreover, while the demand is growing rapidly, so is the supply. Everyone knows about the opportunity, and this has attracted significant developer interest. Even the tenants themselves are increasingly building their own data centers. I think that the demand should be strong enough to exceed the supply, at least in the few years ahead, but the risk of eventual oversupply remains significant.

Finally, I remain concerned about the long-term risk of obsolescence as technology continues to evolve, and this raises concerns about whether we should treat depreciation as a real expense in this sector or not. The server density, cooling requirements, and power usage of today are already very different from just 10 years ago, forcing landlords to heavily reinvest in their properties to stay competitive and not lose their tenants.

Taking all of this into account, the risk-to-reward of owning data center REITs has historically not been particularly compelling in my opinion. You pay a hefty price to capitalize on a clear trend, but there is significant uncertainty due to the questionable capex, huge wave of supply coming in, and the risk of eventual technological obsolescence.

With that in mind, I think that the best data center plays today aren't the most obvious choices that everyone else is buying.

Rather, I think that the best options are a British Industrial REIT with a growing data center platform, replicating the IRM's model, and a major asset manager that's preparing to launch a data center REIT.

Below, I discuss each in more detail: