Infrastructure REITs Towering Over the 5G Economy

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What 5G Is and Why It’s a Game Changer

The introduction of 4G wireless broadband paved the way for smartphones that could access the web at high speeds, creating a surge in data consumption (Exhibit 1). In response, wireless carriers have invested in continuous upgrades to relieve network stress and satisfy consumer demand. But even as they continue to expand and improve 4G coverage, these companies are looking ahead to deliver even faster data speeds and other enhancements through the development of 5G networks, with early rollouts in select cities starting this year.
 
5G technology works in tandem with existing 4G networks to deliver speeds similar to wired fiber connections, while essentially eliminating lag times and drastically reducing power consumption. Initial 5G smartphones are expected to consume 270 times the data of 2G-era feature phones and roughly 3 times the data of current phone models (Exhibit 2).

Exhibit 1: Wireless Data Consumption Is Doubling Every Two Years
Annual U.S. Mobile Data Traffic, Exabytes Per Month

Exhibit 2: A 5G Smartphone Will Use 270x the Data of a Feature Phone
Data Usage By Device, Megabytes Per Month

We believe that deploying 5G networks will require not only increased investments in traditional “macro” cell towers, but also small-cell nodes, interspersed to  provide capacity in areas of higher population density. These nodes can be  placed on macro towers or existing structures, such as traffic lights, street lamps and rooftops, connected to local data centers via underground   fiber.

Once in place, these networks will have the potential to open entirely new commercial applications that are already taking shape.

5G Use Cases

Economic Competition Driving 5G Urgency

Increasing mobile connectivity has historically benefited a country’s economic output, and we expect that to be even more important with 5G. Global auditing and consulting firm Deloitte projected that early adoption and development of 5G technologies could bring more than a decade of GDP growth leadership for first-mover countries.⁽¹⁾ One country in particular has recognized this potential and has moved aggressively to establish early dominance.

Between 2015 and 2018, China outspent the U.S. by $24 billion on 5G-ready infrastructure and built 350,000 individual tower sites—more than 10 times the number built in the U.S. during that period. In all, China has earmarked $400 billion solely for 5G investment under its current Five- Year Plan, not only for domestic infrastructure needs, but also to develop standard essential patents that may consolidate market leadership as 5G expands  worldwide.

The relative spending shortfall in the U.S. has led to calls to accelerate investment to close this gap, or potentially face longer-lasting economic effects. Consulting firm Accenture estimates that U.S. wireless companies will invest $275 billion in building 5G networks, which is expected to create 3 million new jobs and add $500 billion to the  economy.⁽²⁾

Investing in 5G Infrastructure REITs

In our view, rapid growth in data usage in the late-4G environment and the urgent demands of the approaching  5G era are likely to require massive investments to expand communications infrastructure capacity over the next decade. We believe this stands to directly benefit the cell tower industry, where public U.S. companies hold dominant market positions. In addition, we expect the spike in both wireless and wired data traffic to drive sustained demand for data centers.

Public data center and tower operators, which are structured as real estate investment trusts (REITs), span both the listed infrastructure and real estate universes. Their sector weights over the past decade reflect a broader evolution of the U.S. REIT market, which increasingly consists of new and differentiated property types. The first data center REIT, Digital Realty Trust, was listed in 2004, while American Tower was the first tower company to convert to REIT status in 2012. Today, tower and data center REITs make  up nearly a quarter of the U.S. REIT market, valued at $1.1 trillion (Exhibits 3).

Meanwhile, communications infrastructure—tower operators alone—represent around 8% of the listed infrastructure market.⁽³⁾

New economy assets represent a growing part of the U.S. REIT and global listed infrastructure markets

Exhibit 3: Sector Weights and Market Capitalization

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The Core of 5G 

Cell towers are the physical foundation of nearly all wireless connectivity. Tower companies own the vertical real estate— usually a tower or pole—often with the land parcel underneath and the dark fiber cable underground. Wireless  carriers lease space on the tower to mount equipment such as cell transmitters or antennas. In addition to these traditional towers (known as macro towers), tower companies may own small-cell nodes, designed for short-range, high-frequency 5G  signals.

Company examples

• American Tower: Converted to a REIT in 2012, surpassing Simon Property Group as the world’s largest REIT by market capitalization
• Crown Castle International: Converted to a REIT in 2014, with roughly 40,000 towers and 60,000 route miles of fiber across the U.S.; America’s largest operator of small-cell networks
• SBA Communications: Owns tower assets in all 50 States, throughout Canada and in Central and South America; filed as a REIT in 2016

Tenants

• Wireless carriers (Verizon, AT&T, Sprint, T-Mobile)
• Government agencies (police, emergency medical services)
• Broadband data providers/cable companies

Barriers to supply. Two major barriers stand in the way of new entrants into the tower business, starting with local zoning restrictions. There is a legacy of municipal opposition to new towers, enforced under “eyesore laws” designed to protect property values. This often induces carriers to install equipment on existing towers to avoid drawn-out zoning battles. Secondly, tower customers tend to be sticky, rarely moving equipment between tower operators. So new market entrants have fewer potential customers to target in a market where an incumbent tower company is already in operation.

Cash flow profile. Cell tower leases typically start at 10 years with rolling 5–7-year opt-outs. Tenants have tended to experience a 98–99% renewal rate upon expiration, resulting in relatively stable cash flows for the asset owner. Leases also commonly feature annual escalators or inflation-linked adjustments. The combination of these factors has contributed to a generally consistent history of revenue generation for tower companies.

Growth drivers. More data usage requires improvements to existing network infrastructure, and this feeds growth in the cell tower industry. The expansion of mobile broadband coverage to underserved areas could accelerate this trend. Adding more transmitters to existing networks (“densification”) to allow the transmission of higher-frequency 5G signals is also a growth driver. Tower revenue growth has three main components: escalators, colocation and amendments to existing leases.

How carrier consolidation affects tower companies. Cell tower share prices have historically been sensitive to reports of planned carrier consolidation. The pending merger of Sprint and T-Mobile, and possible synergies from the phaseout of redundant tower leases, has raised questions over the potential impact on cell tower valuations. Longer term, we believe that the urgency of 5G buildout needs, as well as a pledge from the pending merger partners to accelerate nationwide coverage (especially in rural areas, where macro towers provide the most effective structural support  for cell transmitters), could pull 5G investment forward, further supporting cell tower fundamentals.

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Landlords of Virtualization 

Data centers are heavily secured warehouses containing rows of equipment racks designed to house network equipment and servers that are critical for data storage and cloud connectivity. These facilities provide sophisticated technical amenities like backup generators, industrial air conditioners and optical connections for linking to business partners and service providers.

Company examples

• CyrusOne: Founded in 2012, with 45 data centers worldwide
• Digital Realty: Owns more than 200 data centers in the U.S. and Europe
• Equinix: Global leader in colocation services; owns 200 data centers in 24 countries on five continents

Tenants

• Cloud services (Amazon, IBM, Microsoft, Oracle)
• Internet (eBay, Facebook, Google, Netflix)
• Financial services (JPMorgan Chase, Morgan Stanley)
• Communications (AT&T, CenturyLink, NTT Communications)

Barriers to supply. While data center shells are simple and straightforward to construct, the cost and complexity of interior infrastructure—cooling, generators and hardwired equipment—involve high initial capital expenditures and operating expertise that constitute high barriers to entry.

The cloud lives in buildings…
By 2021, data traffic from the cloud is expected to account for 95% of total traffic from data centers to end users, compared to 88% in 2016.

Cash flow profile. Data center leases are typically based on electricity/wattage usage in addition to square footage and often include annual rent increases. Leases tend to span 5–10 years depending on the size of the tenant, with historically high retention rates due to the complexity and cost of moving. New development has historically been a key driver of cash flow growth for data centers, often with some portion of the facility committed to a tenant before construction completion.

Growth drivers. Data center growth is being fueled primarily by the need for companies to connect to cloud-based platforms and other business partners. Tenants often form a network ecosystem through colocation that may increase the value of a data center as more tenants locate there. As 5G-era tenants seek to distribute their data storage over a wider geography—closer to end users and to fiber infrastructure we believe these resulting network effects may become increasingly valuable.

One example of this competitive siting is Equinix’s Miami data center NAP of the Americas, which is ideally situated along an underground highway of dark fiber lines and sub-sea  cable landings. The data center is home to more than 600 colocated enterprises, 125 networks, 125 cloud service providers and  40 content and digital media companies, all interconnected to enhance tenant business needs. We believe this type of colocation model could be a standard of differentiation for data centers over time, with location premiums justifying higher valuations.

Implications for Investors

We believe communications infrastructure companies represent an attractive long- term opportunity, driven by potentially massive investments in the 5G buildout in coming years. These sectors have grown to become a significant portion of the public markets today, highlighting the evolution of investable properties tied to the information economy.

Within real estate portfolios, we believe the growing influence of secular themes— whether technology, logistics or demographic trends—may be shifting the REIT market to become less sensitive to economic cycles. In our view, this could enhance the potential of REITs to serve as portfolio diversifiers, particularly in periods of economic uncertainty.

Similarly, within infrastructure portfolios, towers and data centers have shown relatively low sensitivity to macro factors, such as economic cycles and interest rates, while offering relatively attractive cash flow growth profiles. We believe this makes them a particularly appealing and critical element of a diversified infrastructure strategy.