The massive rise of the cloud ecosystem has created a supply and demand strain on a very un-cloud resource – land. Put simply, physical data centers are needed to power the cloud computing world, and more are needed. Because of this, investments in data centers and their operational ecosystems have enjoyed enormous success, and are likely to continue to do so, despite their high fundamental valuations. I should know. Over a year ago, I built a data center real estate portfolio that has generated a realized return of 56%. Encouragingly, sophisticated investors in the space are betting this growth will only continue.
In late July, Iconiq Capital, an investment firm that represents some of Silicon Valley’s most notable tech titans, registered an investment subsidiary called Iconiq DC Management, LLC. The company will operate funds exclusively focused on data center real estate and data center assets. This niche investment thesis includes the acquisition of direct interests in real property, the formation of joint ventures, the acquisition of securities in entities that own or invest in data center-related assets, investment in real estate investment trusts (REITs), and the issuance or participation in financial instruments designed to further catalyze the data center ecosystem.
What’s special about Iconiq? As outlined in a recent article for Bloomberg by Miles Weiss, the Divesh Makan-led firm manages seed to late-stage investment capital for the likes of Mark Zuckerberg, Sheryl Sandberg, Reid Hoffman, Sean Parker, and Jack Dorsey. This rare combination of capital, control, and industry IQ creates a significant proprietary advantage for technology long-plays. Forget industry speculation, this group of household names is comprised of the de facto market-makers in high tech real estate.
Despite the reassuring move by Iconiq, financial rewards for investors at this stage may harbor risks, namely, steep prices for the current bottom line. The high valuation multiples, calculated from price/net income for data center REITs, should prompt caution for any investor with a sense of tech history. High multiples and bubbles are often synonymous with each other, and at times, a rising trend is hard to differentiate from investor herding or deliberate momentum trading. The .com boom and bust shook industry experts and casual market participants alike – acknowledging the absence of market certainty, this could be no different. Even with superstar backing, the data center REIT market is still subject to a pricing correction if the market deems current levels of projected growth to be unrealistic. Furthermore, a rate-hike, or unforeseen macroeconomic events can dramatically alter investor liquidity or perceptions of value.
To warrant a high valuation multiple, data center REITs inherently need to offer a market opportunity that matches lofty return expectations. The thesis of my data center REIT portfolio, and my assumption regarding Iconiq DC Management’s long-term strategy, is to capture growth generated through the data center market's shift from pure tech plays (i.e., Amazon, Facebook, and Google) to the rest of the Fortune 500. Large corporations, in every industry, stand to make tremendous gains from the cloud and robust ecosystem of analytics, operational controls, and customer resources that's spawning within it – when there’s gains or savings to be made, executive will seek them out. As the corporate world shifts from on-premises systems to the cloud, more and more data centers will need to be produced to accommodate the post-tech industry wave of demand.
Perhaps no example is stronger of the corporate transition from on-premises IT solutions to the cloud than SAP. Not only are 87% of the Forbes Global 2000 SAP customers, SAP’s own cloud revenue has grown 30%+, excluding acquisitions, for 12 consecutive quarters. With 110 million subscribers in the company’s growing cloud user base, the operational foundation for the enterprise cloud is clearly here to stay. Placing this information within the context of a long-term investment strategy for the corporate world's own big data needs, it’s reasonable to conclude the data center real estate market will continue sharp growth - Iconiq Capital and I are counting on it.