A cliché often used by property experts is that the three most important factors in determining the desirability of a property are “location, location, location”. While this may be true for real estate companies that lease office space, it is not true for the segment of the real estate industry that leases fiber optic cables. Both benefit from the growth of the “desk job”. But while one thrives in a world where the workplace is centralized, the other thrives in a world where the workforce is becoming decentralized.
A Different Type of Commercial Real Estate Asset
A fiber-optic cable, also known as an optical-fiber cable, is similar in assembly to an electrical cable, except that it contains optical fibers through which pulses of light are sent. The light transmitted forms an electromagnetic carrier wave modulated to carry information. Fiber-optics have become the preferred transmission medium to handle aggressive bandwidth demands, which is why the use of cloud-based applications, audio-video services, and video-on-demand services are strong growth-drivers for the sector. The global fiber optic cable market is expected to expand at a CAGR of +10% between 2020-2026.
While not technically real estate, fiber optic cables, are often owned by property investment firms which then lease them out –- much like office or retail space –- to users, typically telecom companies. Because the Internal Revenue Service (IRS) treats income from such leases as property income, some real-estate investment trusts (REITs) have built up large property portfolios comprised of these cables.
Shift from Corporate Office to Home Office
One of the characteristics that marked America’s shift from a manufacturing economy to a service-dominated economy was the proliferation of so-called white-collar jobs performed within an administrative setting. That shift fueled the growth of real estate companies dedicated to owning and managing office property. For these companies, the game is all about securing a physical structure in an attractive area and then leasing the space to commercial tenants. The more central the location and the greater the number of workers that can be supported at that property, the more rent the property owner can charge, everything else being equal.
The above model, which has benefitted office property REITs, is being disrupted by yet another transformation: the digitalization of the service economy through cloud computing. In turn, cloud computing has fast-tracked the decentralization of the workforce by making it easier than ever for people to work from home. Thus, the transition from corporate office to home office has begun.
The “Railroads of the Future”
In our March 26 report, we wrote about how the nationwide shelter-in-place orders have forced more businesses to operate via the cloud, thereby boosting data center REITs. That same shift, as it turns out, is generating more demand for fiber optic cables. David Guarino of Green Street Advisors recently explained to the WSJ why this is the case.
“Within large offices, data is often sent around through internal networks. When people work remotely and do much of their work over cloud-based applications, they send more data through fiber cables.”
So, the more people work remotely and use cloud-based tools like Zoom video or Microsoft Team to engage with each other, the larger the amount of data that has to be transmitted, and the greater the need for increased bandwidth via fiber optic cables.
The lockdowns forced a great telecommuting experiment on the world and has changed many attitudes about the efficacy of remote work. After the lockdowns have ended, thousands of companies will likely fully embrace a remote work culture, or they will adopt a hybrid model. In any case, the use of cloud-based applications will grow, and more data will get transmitted via fiber-optic cables than before the COVID-19 pandemic, delivering a win to this obscure segment of the real estate industry. The upcoming transition to 5G is another positive catalyst for this sector.
One REIT executive sums up the opportunity as follows: “These are literally the railroads of the future.”
How to Invest
There are three ways for investors to gain exposure to growing demand for fiber-optic cables.
REITs that specialize in digital infrastructure assets are a way to invest. One example is Crown Castle International (CCI), a Houston-based REIT that owns more than 80,000 route miles of fiber optic cable in addition to 40,000 cell towers across the United States. The company counts America’s four telecom giants — Verizon, AT&T, Sprint and T-Mobile — among its clients, and they supply 74% of Crown Castle’s site-rental revenue, according to Forbes. Part of Crown Castle’s appeal to investors is the revenue certainty from its long-term leases. As of November 2019, Crown Castle had a weighted average remaining lease term of five years.
When it comes to technology, many companies that make the components of popular products wind up being much more profitable than firms that use said components to make a finished product. With that logic in mind, companies that make components for fiber optic cables should thrive. Ciena Corporation (CIEN) and Lumentum (LITE) are just two publicly-traded companies that investors can choose from in this space. Each could see growth as more fiber-optic connections are rolled out for cloud computing, 5G, and faster home internet services.
The Pacer Benchmark Data & Infrastructure Real Estate SCTR ETF (SRVR) offers exposure to companies that derive at least 85% of their earnings from real estate properties related to data and infrastructure. Half of the portfolio is invested in data center REITs while the other half is allocated to REITs that own fiber optic cables and cell towers.
The fact that these three groups of securities –- the Crown Castle REIT (CCI), the component manufacturers (CIEN, LITE) and the data & infrastructure ETF (SRVR) — outperformed the market both during the downturn and on the rebound reflects their strong positioning in a world increasingly dominated by the cloud and in which telecommuting could become the norm.
Managing Director, Research
McAlinden Research Partners