Hybrid Cloud Growth Powers Data Center REITs 19.6 Percent Higher

The first quarter was a very choppy environment for global equities, but it was clear sailing during Q1 2016 for publicly traded data center REITs.

Now the question investors need to answer: Is this the right time to jump aboard this fast moving train?

The S&P 500 rallied to finish slightly higher for the quarter ended March 31, 2016, with an assist from Fed Chair Janet Yellen's recent dovish comments. However, it took a record rebound from mid-February lows -- the biggest bounce since 1933 -- for the S&P 500 to eke out that gain.

Meanwhile, data center investors were raking in the chips for the third straight month, after most of the sector reported record leasing results over the past few weeks.

Since the beginning of the year, share prices for an evenly weighted portfolio containing all six data center REITs would be up an impressive 19.6 percent.

Read more: Data Center REITs Scored Big in 2015 Despite Weak Markets

That was on top of outstanding data center sector performance in 2015.

A Rising Tide Lifts All Ships

Lease signings were strong in Q4 2015 for multi-megawatt cloud computing deployments, along with significant demand for colocation square-footage and interconnection growth.

This momentum has continued during Q1 2016, spurring investor optimism, which borders on a data center sector feeding frenzy.

By the end of March 2016, more than half of the sector was trading above analyst consensus 12-month price targets.

Of course, investment banks that remain bullish on the sector may choose to increase earnings estimates for 2017 and beyond, on a case-by-case basis.

Notably, DuPont Fabros, CyrusOne, and QTS Realty all recently floated large secondary share offerings, taking advantage of share prices near 52-week highs. This would usually cause a small, but noticeable drop in share prices; however, investor appetite to own these names was so strong, share prices powered higher.

DuPont Fabros - Wholesale Gains

In a departure from last year, DuPont Fabros Technologies is leading the way 2016 year-to-date, with 31.5 percent price appreciation. The acceleration of capital spending by hyperscale public cloud providers, including top tenant Microsoft, is great news for DuPont Fabros.

During Q4 2015 DuPont Fabros signed 12 leases totaling a record 32.3 MW of critical load. DuPont's data center portfolio, containing an aggregate 266 MW of critical load, was already 98% leased at the end of last year.

Read more: DuPont Fabros Firing on All Cylinders: Time to Step on Gas?

On March 17, DuPont Fabros announced that it had signed another 27 MW of critical load with existing hyperscale and large wholesale customers. This demand was concentrated in the Santa Clara and Chicago markets, including the 16 MW pre-lease of the entire third phase of SC1, a 64,000 square foot facility.

DuPont Fabros announced expansions into the Toronto and Hillsboro, OR (Portland) markets, to be partially funded by the previously announced exit from New Jersey, and sale of NJ1.

Read more: CyrusOne Reports Record 2015, Plans Big New Jersey Expansion

Meanwhile, CyrusOne recently announced its intention to expand into the New Jersey market, as part of a broader strategy to expand its product offerings to the financial sector.

CyrusOne - Investor Day Momentum

During its 2016 Investor Day presentation earlier this month, the company rolled out a bold plan to double its enterprise value from $4 billion today to $8 billion by 2020.

Read more: CyrusOne Rolls Out Five-Year Plan to Double Its Value

On April 1, CyrusOne closed on the 15-year sale-leaseback 428,000 square foot CME Group Globex data center. This deal was announced on March 15 and coincided with a CyrusOne secondary equity offering. CONE floated 6.9 million shares at $38.50 per share to help fund the deal and reduce leverage, (balance sheet debt to equity).

Bottom Line

A lot of the good news for 2016 is already baked into the 19.6 percent gains year-to-date.

Equinix is digesting and integrating Bit-isle (Japan) and Telecity (Europe) acquisitions, with most of the revenue synergies expected in 2017 and beyond.

Likewise, Digital Realty is busy integrating and expanding its Telx colocation and interconnection footprint, with revenue synergies expected in 2017 in the US, with international expansions slated for the future. However, the announcement of wholesale wins could help lift shares higher.

DuPont Fabros has minimal vacant space available which limits additional revenues which can hit the bottom line in 2016.

However, data center REITs with existing shell space available for expansion are able to deliver space in a matter of months, rather than in a year or two. Therefore, new lease signings announced during the second quarter of 2016, can still boost results for the second half of the year, and augment 2017 earnings estimates.

Investor Takeaway

If you are already a shareholder of one or more of these top performers, go ahead and pop the cork on that special bottle of champagne. On the other hand, investors looking to initiate or add to an existing position should keep in mind that current share valuations are also frothy.

While catalysts exist for the data center REIT sector, my sense is major announcements or earnings beats will be required to move individual names higher from here.

Federal Reserve interest rate moves could spark a REIT sector pullback, creating buying opportunities prior to the next leg up in share prices. However, given the industry tailwinds of cloud computing and data growth, I wouldn't hold my breath waiting for bargain-bin pricing.