Digital technology is changing lives, economies and businesses on a global scale. The spread of mobile devices has accelerated the movement of many of our transactions, processes and leisure activities to the online world. With the promise of accelerating connectivity, advances such as artificial intelligence, autonomous driving and the “internet of things” are coming closer to fruition. Inevitably, such changes are affecting underlying physical infrastructure and real estate, both in the destruction and devaluing of the obsolete and the creation of the new. The world may need fewer stores, but more logistical capability; less paper, but more data storage; fewer interstates, but faster digital highways.
We are seeing this transition occur in real time for real estate securities. Yes, technology has introduced some fallout and potential risks, but it has also contributed to dynamism and a growth profile that we believe should continue to benefit real estate companies. In this Insights, we discuss real estate segments where technology is having a particularly meaningful impact.
Cell Towers: Connectivity Linchpin
Back in the ’90s, U.S. phone companies generally sold their cell tower assets to pay for fiber optic buildouts, and the majority are now owned by listed real estate companies. They rent out space to wireless carriers, which mount equipment such as cell transistors and antennas. With the growth of data from smartphones, the towers have seen explosive demand over the last decade. And they are typically geographically dominant, approved by local governments and protected by the “not-in-my-backyard” mentality of residents who want strong cellular service, but don’t want to see additional, ugly infrastructure. As a result, cell towers enjoy high barriers to entry and pricing power, even as the number of major customers—largely the national carriers—remains low.
The transition to 5G will introduce new dynamics to the tower business. Past technology rounds have relied on lower frequencies that could travel longer distances—i.e., between cell towers. However, available bandwidth is now largely at high frequencies, which work best at closer distances, while the new generation of applications, including self-driving cars, requires densely packed signals to limit latency (or response time), reinforcing the need for many more, closely spaced signals. This will translate into a large number of “small-cell” antennas, which are likely to be placed not only on cell towers, but on traffic lights, bus stops, building walls and other “street furniture.” Obviously, obtaining the necessary approvals from local governments across vast geographies will require considerable time and money, and many expect a full rollout of 5G to take as long as a decade.
The cell tower companies are applying various approaches to the 5G trend, with some diversifying significantly into small cells and fiber, and others taking a more wait-and-see attitude. Ultimately, 5G will wind up with a complementary set of capabilities, combining towers and smaller antennas. One risk involves the consolidation of the wireless industry. Recently, a federal judge approved a merger that would reduce the number of existing national carriers from four to three, although with the possible establishment of a fourth player to maintain competition. With the combination, many analysts expect a sharp increase of capital expenditures to upgrade networks. This, in addition to an already enormous potential buildout of 5G infrastructure, should help maintain the central role of cell tower companies in telephony and data for years to come.
More Broadband Will Require Robust Cell Towers
U.S. Data Traffic by Device Type (in petabytes/month)
Source: Cisco VNI 2016; Ericsson Mobility Report, June 2018; Altman Vilandrie & Co. IoT=Internet of Things.
Average Data Used by Activity (in megabytes)
Source: American Towers company presentation, Altman Vilandrie & Co. research, Verizon, AT&T.
Data Centers: Where ‘the Cloud’ Gathers
Most people have a vague sense of the internet and cloud, but don’t associate them with vast nondescript warehouses that house their physical backbone. Data centers provide infrastructure for tenants with various enterprise and computing needs, and hold millions of terabytes of data for individuals and companies. Although the profiles vary, they typically fall into two categories: wholesale and colocation. Wholesale sites are no-frills operations that provide large blocks of space at relatively commoditized prices. Colocation sites may have multiple tenants whose close proximity allows for connectivity advantages; they tend to offer more services at higher prices.
Data centers have proliferated with the growth of internet traffic and the advent of mobile devices, and rapid migration of data storage from local sites to the cloud has accelerated that growth. With this trend, however, have come new tensions between the data centers and their largest customers, a handful of mega-companies that provide “public cloud” services. As the share of these companies has expanded, data centers have experienced less contact with end customers and weaker pricing power. They have sought to offset this with M&A activity that is focused on highly valued “interconnection” assets located at key points on the digital map. All told, however, the continued growth of the cloud, business outsourcing, the 5G ramp-up, artificial intelligence, blockchain and myriad other data-intensive trends should contribute to accelerating demand for storage over the next decade.
Cloud Computing Is Driving Data Center Demand
Revenue from Cloud Business
Source: Green Street Data Center Insights.
Fallout and Opportunity Tied to Retail
The growth of digital commerce continues to have massive impacts on the retail sector, with a record 9,300 store closures announced in the U.S. last year. E-commerce (as measured by non-store sales) grew by 13% in 2019 compared to 3.6% for retail generally.1 Without denying the severity of the situation, it seems that some investors believe that physical stores could disappear altogether; in fact, we see retailer and online operations as potentially complementing one another and anticipate strong players adapting to, and capitalizing on, the digital shift.
E-commerce vs. Brick & Mortar Sales Growth (Indexed to 100 in 2005)
Source: Bureau of Economic Analysis, Federal Reserve, Oxford Economics and Green Street Advisors.
Many traditional stores and malls that enjoy prime locations are benefiting from online sales as they double as pick-up locations for goods bought online (known as BOPUS: “buy online, pick up in store”). A higher proportion of goods bought online are returned as well, and customers often like taking their purchases back to a real person in a local store if they have the option.
Moreover, the rapid growth of deliveries is driving the real estate-intensive trend of “e-fulfillment,” which is employing a range of assets, from warehouses to regional service centers to local self-service lockers and pick-up locations. Wider product choice, smaller orders and increased incidence of product returns mean that e-commerce also uses more of those assets than traditional retail. As a result, while retailers slow their physical store openings, many remain committed to the top locations, while leading U.S. online brands, notably including Amazon, have been opening brick-and-mortar stores as well.
The best-located malls are also the ones better able to adapt their retail offerings to current pressures. For example, the primary mall in a large and thriving community should be able to swap out at-risk apparel stores for assets with more potential, including grocery stores, restaurants, gyms and bars, as well as movie theaters and other entertainment offerings.
Consolidation has begun among the owners of the highest-quality regional malls. Over the past three years, three large regional mall portfolios have transacted and landed in the hands of stronger, better capitalized owners. We have even seen large U.S. mall REITs team up to acquire and restructure two struggling retailers. In our view, the best retail landlords are not standing still; they are seeking to increase their market share and reshape their portfolios in ways that can help them succeed in the new multichannel retail environment.
Malls for Moderns
Source: Green Street Advisors.
Real Estate’s New Growth Profile
The trends we’ve noted are part of a broader shift in the listed real estate universe, reflecting an array of new growth opportunities. Beyond tech- and logistics-related themes, an aging population is requiring additional health care facilities. Increased leisure spending is generating demand for hotels, casinos and related assets on a global basis. On the more traditional side, we also see growth potential in the residential sectors, supported by demand from millennials, as well as solid jobs growth and an improved rate of household formation. All of this suggests that the fundamentals that helped drive market gains recently can continue to lend support to real estate securities well into the future.
U.S. REITs: An Evolving Mix of Assets
Source: FTSE Russell, as of January 1, 2019.