Real-estate investment trusts, or REITs, have not performed well recently. Over the past six months, equity REITs have underperformed the S&P 500 by nearly 14 percentage points, mainly thanks to rising interest rates.
This has created some pretty compelling bargains in the real-estate sector. One in particular that I bought more of recently was 3.8%-yielding Digital Realty Trust (NYSE: DLR), which in late February dipped below $100 per share for the first time since 2016 after weak results from a competitor spooked investors and caused all data-center REITs to plunge.
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What Digital Realty Trust does
Digital Realty Trust is a real-estate investment trust that owns a large portfolio of 203 data centers in the U.S. as well as in international markets. The company's data centers contain more than 32 million square feet of rentable space, which is leased to more than 2,300 customers.
Speaking of customers, Digital Realty's tenant list reads like a "who's who" of leading technology and financial companies. Top tenants include IBM, Facebook, Oracle, Verizon, AT&T, JPMorgan Chase, and Uber, just to name a few.
If you aren't familiar with data centers, they are buildings designed to house servers and network equipment in a secure and reliable environment. As one example, when you upload a photo album to your favorite social media site, those photos need to be stored somewhere. This is why data centers are necessary.
Why invest in data centers with Digital Realty?
As you might imagine, with the surge in social media, mobile data, and cloud computing, the need for data centers has soared in recent years. And, the growth isn't expected to slow down anytime soon. In addition to current catalysts, there are entirely new growth drivers that are starting to emerge.
For example, the abundance of connected "Internet of Things" devices is expected to roughly double over just the next two years. The number of autonomous vehicles (which generate lots of data) is projected to grow at a 37% annualized rate through 2025. And the artificial intelligence market is expected to grow from a roughly $4 billion market today to $60 billion by 2025. In short, the growing need for secure and reliable data storage isn't about to slow down -- if anything, it could accelerate in the years ahead.
Digital Realty is a proven leader in the data-center business, with an excellent track record. The company has grown its FFO (funds from operations -- the REIT equivalent of earnings) at a 12.3% annualized rate since 2006 and has been able to raise its dividend at roughly the same pace. And it has done this while maintaining a more conservative balance sheet than most large REITs.
Finally, although Digital Realty is among the largest REITs in the market, there's still lots of growth potential. In addition to the industry growth catalysts I discussed earlier, Digital Realty has room to dramatically expand its footprint in international markets. While the company operates in 11 foreign countries, the vast majority (80%) of Digital Realty's rental income comes from the U.S.
An excellent long-term opportunity
Digital Realty has rebounded somewhat since I added some shares to my portfolio, but by no means would I call its current $106 share price "expensive." In fact, at 16.2 times 2018's expected FFO, I'd still call the stock pretty cheap, especially considering its remarkable growth opportunity.
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Matthew Frankel owns shares of AT&T and Digital Realty Trust. The Motley Fool owns shares of and recommends Facebook and Verizon Communications. The Motley Fool owns shares of Oracle. The Motley Fool is short shares of IBM and has the following options: short June 2018 $52 calls on Oracle and long January 2020 $30 calls on Oracle. The Motley Fool has a disclosure policy.