Why You Should Consider “Mission Critical” Real Estate

Real estate is interwoven into every part of the economy. Keen real estate investors know they can own a slice of casinos on the Las Vegas strip, cell towers powering cell phones all around the world, data centers feeding the appetite of artificial intelligence, industrial buildings driving e-commerce, and more common real estate like office and apartment buildings.

Publicly traded real estate investment trusts (REITs) offer exposure to all those areas, and we’ll mention several in this article. Private funds also target many of these property types and without the volatility of trading on an exchange like REITs. The main trade-off of using private funds is less liquidity, but there may be others plusses and minuses to consider.  

Regardless of how you own them, these different types of real estate have their own lease structures, rent growth, tenants, and risk factors.

But there is a “hidden” category that even many experienced real estate investors don’t know about. ElmTree and Guggenheim, two financial juggernauts, were among the first to specifically target it.

You won’t find it listed on Nareit’s website, which is the industry leader in identifying and tracking different types of real estate investment. That’s because it isn’t a specific category of real estate like offices or hotels. Nor do the properties use a similar lease structure or have tenants that are primarily in the same sector. That’s how most types of real estate are defined, but not this one.

Instead, it is how essential the asset is it is to the tenant that distinguishes this class of properties. And I’m not referring to just financial value.

Truly mission critical real estate is so important that the organization can’t survive or effectively operate without it.

For me, the Pentagon comes to mind. It’s so critical that many people use the Department of Defense and the name of its headquarters interchangeably. The 27,000 people that work there everyday rely on the Pentagon’s unique design and capabilities to keep the Department of Defense running.

You can probably imagine many government buildings with similar importance. But the same rule applies to many companies and industries. Caesars Palace in Las Vegas is an icon of the strip, and one of its economic pillars. For Caesars Entertainment, the tenant, it’s hard to imagine parting with the property.

The building is owned by Vici Properties (VICI), a publicly traded REIT with a diverse portfolio of 54 gaming, hospitality, and entertainment properties in North America. Besides Caesars Palace, it also owns MGM Grand, The Venetian, and several other venues that are essential to their tenants’ businesses. That’s why when most retailers were suffering during the pandemic, Vici collected 100% of rent from its Vegas tenants.

Another example is data centers. These are specialized buildings full of servers, network equipment, cooling infrastructure, and power systems. Odds are that the computer or phone you are using to read this article is relying on a data center right now.

And it’s not just your iPhone or Android. Microsoft (MSFT), Alphabet (GOOG), Meta Platforms (META), and many other companies cannot operate their businesses without reliable access to data centers. Even the water consumption to cool the facilities is considered a trade secret. Any major player in the artificial intelligence or crypto industries is also heavily dependent on data centers. If one goes offline, so does their business. And potentially so will their customers and investors.

Like we mentioned before, there are both public and private funds focused on mission critical assets like data centers. Interestingly, the leaders in the industry tend to go back and forth. In 2021, Blackstone (BX) acquired publicly traded REIT QTS Realty Trust (QTS) and took the company private. It’s one of many publicly traded data center REITs that was purchased by investors in the private markets in recent years.

Certain industrial properties are in the “mission critical” bucket too. While I understand why people might think there is practically infinite space to build big warehouses, they’d be wrong.

Industrial and logistics facilities are strategically planned and located. The land just outside major cities and adjacent to major highways is limited. Go any farther out, and Amazon’s 1-day shipping guarantee and the like won’t work. There isn’t room for a million square foot or greater building closer to town, and even if there was, it would be far too expensive for those “free shipping” policies.

And without proximity to major highways, trucks carrying goods can’t get in and out efficiently. That won’t do either. So, for companies like Home Depot (HD), FedEx (FDX), and Amazon (AMZN), their customized logistics facilities in major markets aren’t a convenience or cost reduction tool. Without them, their businesses don’t work. The same principal applies to specialized manufacturing facilities.

The last mission critical real estate I’ll cover certainly proved its value in recent years. Life science includes laboratories and research facilities. These specialized properties are difficult or impossible to replace for several reasons.

First, they are often located in a “cluster” that cannot be duplicated elsewhere. Think of a university campus, a mix of private and public research institutions, and the purpose-built laboratory that figuratively and literally connects them all together.

Alexandria Real Estate Equities (ARE) is a publicly traded REIT specializing in these property types.

Second, unlike most real estate, each properties’ equipment and technology may be developed over years, and even decades, to suit exactly the kind of research being conducted. This makes it all but impossible for the leaseholder to relocate to save a few dollars on rent.

Lastly, there are long timelines associated with the activities of the facilities’ users. Historically, grants from the National Institute of Health are for four or five years.  This started increasing toward seven years around 2018, and after medical research’s value was on full display during the pandemic, there are active efforts for even longer-term funding. That’s not to mention the opening of medical schools and other projects that have anticipated lifetimes of 50 years or more.

Conclusion

Mission critical real estate is in its own class. But it also requires a deep understanding of the industry and tenant to identify. The categories shared today will help point you in the right direction, and there are new kinds of mission critical real estate built every year. As proven by Vici Properties’ perfect rent collections during the pandemic and Alexandria Real Estate Equities, Inc’s strong long-term performance, mission critical real estate has the potential to reward investors.

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Nothing in this blog is or should be construed as investment advice or an offer or solicitation of offers of investments. Both Real Estate Investments and Securities offerings are speculative and involve substantial risks. Risks include but are not limited to illiquidity, lack of diversification, complete loss of capital, default risk, and capital call risk. Investments may not achieve their objectives. Investors who cannot afford to lose their entire investment should not invest in such offerings. Consult with your legal and investment professionals prior to making any investment decisions. All Securities are offered through North Capital Private Securities, Member FINRA/SIPC.