Economic growth has clearly slowed both in the US and around the world, and that’s before we account for the impact of the coronavirus. Despite the tax cuts, rate cuts, fiscal stimulus and government deregulation, US GDP expanded at 2.3% in 2019, precisely in line with the average of the last 10 years.1 But there are some bright spots—and one of them includes the cell tower and data center real estate investment trusts (REITs) that should benefit from the coming wave of 5G.
What exactly is 5G and why should investors care? Every investor with a cell phone understands that 5G (or fifth generation) is the next step in the technology progression of wireless connectivity from 2G to 3G to 4G (see chart 1). 5G works in tandem with existing 4G networks to deliver speeds that are similar to those of wired fiber connections, while essentially eliminating lag times and drastically reducing power consumption and signal interference. Initial 5G smartphones are expected to consume 270x more data than 2G-era phones and roughly 3x the data of current phone models.2 What many investors may not appreciate is how big a step change 5G could be and how long it could act as the growth gift that keeps on giving.
In this regard, we believe 5G will differ in kind from earlier generation wireless technologies. While 2G through 4G were largely driven by consumer usage and applications, 5G will expand the industrial and enterprise use cases for mobile connectivity by enabling a volume of simultaneous connections that was not available previously, at data speeds not available previously and with a ubiquity of coverage not available previously. The sheer number of devices that can be managed simultaneously on a wireless network could usher in a new era of machine-to-machine communications that finally makes the internet-of-things a large-scale reality. Simply put, 5G holds the promise of 10x faster speeds than 4G with 1/50th the latency and should support up to 100x more simultaneous connections than prior generations of technologies.3 Through a combination of developer creativity, user ingenuity and network effects, we believe that new use cases for mobile connectivity will emerge that are not practical or even possible today.
For example, many investors have read about self-driving vehicles, and some have even seen prototypes driving around cities in the US. But what many may not appreciate is the volume of data necessary for the technology to work along with the necessity of seamless coverage, low latency and robust mobility features. A single driverless car could generate as much data as ~3,000 current-model smartphones.4 Industry experts estimate that a large-scale rollout of autonomous vehicles could increase global wireless data traffic by up to 40x over current levels—a step change in volume that would overwhelm the capabilities of 4G but could become a reality with 5G.5
Other 5G use cases could include remote healthcare, smart manufacturing, smart cities, drones-as-a-service, connected transportation and augmented reality/virtual reality, among others. Simply put, 5G could become the critical value driver for global telecom companies over the next ten years. Industry experts project that capital expenditures for the 5G buildout could top $2.0 trillion worldwide, including over $270 billion in the US to cover spectrum, base transceiver stations, transmission, cell towers and related infrastructure.6 Moreover, 5G is not simply a secular growth play in the US. We expect to see meaningful 5G-driven growth in Europe, Latin America and Asia Pacific, although each market has its own investment dynamics and will develop on its own schedule.
Of course, secular growth waves driven by new technologies are never risk free, and broad deployment of 5G will face certain challenges. For example, the high radio frequencies used in 5G cannot travel as far as current 4G wavelengths, necessitating network densification. In addition, 5G frequencies have greater difficulty moving through objects, which means the technology will require an enormous expansion of current cell tower and small cell node infrastructure in order to function. Beyond the technical challenges, 5G will face issues related to permitting, spectrum allocation, regulatory buy-in and carrier consolidation. On balance, however, we expect the 5G wave to drive a multi-year period of secular growth for telecom companies and related industries.
How to invest in 5G? There are numerous ways to invest in the coming wave of 5G. These include telco service providers, equipment manufacturers, spectrum holders, fiber providers, construction companies, cell tower owners and data centers, among others. We prefer the owners of critical communications infrastructure—including cell tower and data center REITs—for several reasons. First, towers and data centers have shown relatively low sensitivity to macro factors such as economic cycles and interest rates while offering attractive cash flow growth profiles. Second, the infrastructure is must-have, not nice-to-have, for the buildout of 5G. Third, they can support continued growth in data usage, and their business models (and the economic rents they capture) are highly scalable. Fourth, incumbency is a valuable moat around their businesses. We expect 5G to leverage much of the same infrastructure used in current 4G networks, and the incumbents own that infrastructure. When it comes to towers, new entrants often face onerous zoning restrictions designed the protect property values. This often induces carriers to install new equipment on existing towers to avoid lengthy zoning battles. Not surprisingly, tower customers tend to be quite sticky, which means tower companies typically enjoy high rates of customer renewals. This dynamic translates into stable and predictable cash flows for the asset owners, and long-term leases that typically include annual inflation-linked adjustments. We also expect the spike in both wireless and wired data traffic driven by 5G deployments to create meaningful sustained demand for data centers.
Today, tower and data center REITs make up a meaningful portion of the U.S. REIT market and are valued at approximately $400 billion.7 In the US, the leading tower companies include American Tower, Crown Castle and SBA Communications. The leading data centers include Digital Realty, Equinix, CyrusOne, QTS, CoreSite and Switch. A host of additional companies serve markets outside the US.
Why will the cell towers and data centers benefit from 5G? Investors have seen this movie before. In both the 3G and 4G cycles, infrastructure players like tower companies and data centers were major beneficiaries of the initial network buildout, and then continued to benefit as customer use of next generation technologies drove ever increasing network traffic. As 5G expands, we believe cell towers and data centers will remain must-have infrastructure. The addition of more transmitters to existing networks (i.e., densification) and the construction of potentially thousands of new small cell nodes should allow the transmission of higher frequency signals that are necessary in a 5G deployment.
Stepping back for a moment, 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 a land parcel underneath and the fiber cable underground. Wireless carriers, broadband providers, cable companies and government agencies lease space on towers to mount equipment such as cell transmitters or antennas. In addition to traditional towers (known as macro towers), tower companies may own small cell nodes designed for short-range, high frequency 5G signals. Towers and small cell nodes serve as the edge of the wireless network and are the first point of connection for end-user devices. Towers offer one of the most cost-efficient ways to deploy wireless spectrum. The physical structures are unlikely to change in a 5G network, although the equipment placed on them certainly will. Their ability to serve a large population across a wide geographic area from a single location makes them ideal for serving the expected 5G growth in consumer, industrial and enterprise demand.
The 5G buildout should also push tower companies to build more small cell nodes. Like macro towers, these nodes function as the edge of a wireless network and consist of equipment that is often attached to utility poles, signposts or streetlights. Because they are low-powered and sit closer to the ground, small cell nodes are an ideal way to meet growing data demands in a more precise and targeted way—especially in densely populated areas including stadiums, convention centers, campus environments and offices. They work seamlessly with towers to increase capacity, and because they are fiber fed, small cells can support the high speeds that 5G requires.
Data centers are secured warehouses containing equipment racks that house network equipment and servers that are critical for data processing and storage as well as cloud connectivity. These facilities provide sophisticated amenities like backup generators, industrial air conditioners and optical connections for the linking of business partners and service providers. In a 5G network, additional computing capacity and storage will be needed closer to the network edge to meet the low latency needs of customers. While data center shells are relatively simple to build, the complexity of the interior infrastructure requires high upfront capital expenditures and a level of operating expertise that constitute significant barriers to entry. Not surprisingly, lease terms are often 5-10 years and data center REITs typically enjoy high customer retention rates due to the complexity and cost of moving. Tenants often form a network ecosystem through colocation that tends to increase the value of a data center as more tenants locate there.
A bright spot in commercial real estate. The business case is solid, customer demand is real, the telecom carriers are committed and the 5G wave is coming. We expect telecom carriers both in the US and around the world to make a massive investment over the next 5-10 years in the infrastructure necessary to enable 5G. We also believe the tower and data center REITs are uniquely positioned to benefit from the initial multi-year infrastructure buildout, and later from the step change increase in data transmission that will result from 5G deployments. We view the expected scale and durability of the 5G-driven growth wave to be a very bright spot in the commercial real estate landscape.
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1. Source: Bloomberg L.P., 3/5/20.
2. Source: Vella, H., 5G vs. 4G: What Is the Difference?, Raconteur (2019); 5G vs. 4G: A Side-by-Side Comparison, Western Digital (2019).
3. Source: Fritzsche, J., et al., 5G Big Picture Thoughts / Primer, Wells Fargo Securities (2019).
4. Source: Barua, S., Flood of Data Will Get Generated in Autonomous Cars, Auto Tech Review (2020).
5. Source: DeGrasse, M., Autonomous Vehicles, FierceWireless (2018).
6. Source: Busvine, D., 5G Infrastructure, Disruptive Asia (2019); Roy, H., Tackling the Cost of a 5G Build, Accenture Strategy, (2018).
7. Source: Bloomberg L.P., 3/5/20.
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