The REIT Newsletter for Advisors • Fall 2023
A Tailwind for Towers:
A Closer Look at the Cell Tower REIT Sector
By Darin Turner, Managing Director and Chief Investment Officer, Listed Real Assets, North America at Invesco Real Estate
Cell phone tower REITs are one of the most differentiated and unique areas of listed real estate. They offer a combination of structural growth, stability and predictability unlike almost anything else in the real estate securities space. The purpose of cell phone towers is the provision of infrastructure that allows for wireless communication. The business model is exceptionally stable, low cost and highly oligopolistic. New technologies including 5G should provide a tailwind for cell phone towers as consumers demand faster speeds across a broader pool of devices over time. This article should serve as a primer for one of the most interesting and innovative sectors in real estate.
The Importance of Towers
The increased utilization of mobile devices over the past 30 years has made towers a mission-critical component of infrastructure-related real estate. A tower is a pole structure on a property that hosts physical telecommunications equipment, including antennas and fiber cables. Antennas transmit and distribute different forms of radio waves that allow for the basic functionality of communications and technology devices. Fixed wire transmission lines are installed at the tower’s base and are interconnected with a communications superhighway underground both domestically and globally. There is also a station at the bottom of each cell phone tower that has backup generators and other equipment to ensure constant service. In addition to large macro towers, which are highly visible and ubiquitous, small cell antennas are also being affixed to light posts and other structures in denser urban areas to increase data capacity.
The cost to operate a cell phone tower site is exceptionally low compared to other forms of real estate, allowing for the potential for outsized gross margins for this property type. The tower structure and land is owned or controlled by the tower operator. However, all other equipment associated with the site are the responsibility of the tenants. That includes antennas, radios, base stations and underground fiber cabling. Cell phone tower structures are critical to telecommunication tenants who generally do not own large tower portfolios and cannot provide significant service without them.
Cell Tower REIT Oligopoly
Roughly 100,000 cell phone towers (or ~80% of the market) are owned by an oligopoly of American Tower, Crown Castle and SBA Communications. Each of these companies started from humble beginnings several decades ago but stands amongst the largest REITs in the world by market capitalization. They have likewise generated some of the best long-term annualized returns of real estate securities worldwide.1 Private market operators, by contrast, do not factor much into the space, given the exceedingly high barriers to entry to form a cell tower network of tens of thousands of sites. The tenant base for cell phone tower sites is dominated by telecommunication providers AT&T, T-Mobile and Verizon. But there is scope for additional tenants over time as 5G and its offerings evolve.
The leasing structure for cell phone towers have some similarities and differences relative to more traditional real estate sectors. Telecommunication operators generally sign non-cancellable contracts with a weighted average lease term of roughly 10 years. Tenants are required to pay 3% annual rental escalators, which often helps keep pace with inflation. There are a couple of ways of increasing tower revenue over time. The first is contractual amendments which require tenants to pay additional rent when they add more equipment to a tower. The second is through tenant colocation. The cash flow, gross margins and return on investment (ROI) of towers increase significantly when a second or a third tenant is added to a single tower. Today, the average number of tenants per tower nationally stands at 1.8 communication providers. Supply growth of macro towers has stalled in recent years, which has helped contribute to the rising cash flow of existing structures.
5G is gradually being rolled out and will eventually become the standard wireless technology in the United States. 5G will be able to handle considerably higher data loads at much faster speeds and across a broadening array of devices. Mobile device owners will see faster download speed, better wireless connectivity and better battery life. 5G will also enable the future function of smart cities with provisions for electric grids, streetlights and water utilities. Self-driving cars will also become possible as 5G will offer the ultra-low latency to tackle the real time needs of driving. And more household devices will be connected to communication networks. The “internet of things” covered by 5G will allow for smart homes with connections to home security systems, cameras, thermostats and lighting.
Expect to see a lot more small cell antennas in weaker coverage averages with network congestion. Small antennas will be affixed to streetlights, utility poles and building roofs to ease congestion in dense urban corridors, stadiums and other gathering areas to reduce the bottleneck challenges in situations with demand spikes. The oligopoly to cell tower real estate investment trusts (REITs) has collectively invested heavily in this area.
The Case for Cell Tower REITs
Cell tower REITs may offer a compelling alpha opportunity for investors in coming years, particularly with a growing likelihood of an economic slowdown. The demand inelasticity for cell tower REITs, tailwinds from tenants through 5G and a broadening spectrum of applications could provide ballast in a more difficult fundamental environment for other property types. After a challenging calendar year in 2022 in which low cap rate and longer duration sectors underperformed, cell tower REITs today are offering a healthy combination of strong fundamentals and inexpensive valuation. Invesco Real Estate expects that cell tower REITs will offer low to mid-single-digit Net Operating Income growth over the next three years. On the valuation front, after a challenging calendar year, given the sharp rise in interest rates, cell phone tower REITs trade at roughly a -10% discount to net asset value and implied cap rates have reset to 5% as of March 31, 2023.
Despite weak performance in 2022, cell tower REITs have been amongst the best performers in the REIT universe over longer cycles.2 Over the past twenty years, American Tower, Crown Castle and SBA Communication have achieved annualized returns of 20.7%, 18.8% and 30.4%, respectively.3 Those returns are well above the broader real estate securities index FTSE NAREIT All Equity REITS Index and the S&P 500, which generated 9.4% and 10.4% annualized returns, respectively.2,3
Furthermore, with the potential for an economic slowdown on the horizon engineered as the Federal Reserve continues to tighten money amidst persistent inflation, the cell tower REITs space could be poised to potentially outperform given their stability and inelastic demand characteristics. During the last two major economic downturns during the COVID epidemic and the Global Financial Crisis, cell tower REITs outperformed by a very significant amount versus the broader REIT market, +13% outperformance during the GFC and +34%% outperformance during the COVID epidemic.4 The stability and relative inelasticity of the cell tower infrastructure business has created a relatively safer haven during downturns as occupancy rates and cash flows are relatively unaffected. Given the stickiness of prevailing inflation, another of the relatively attractive attributes of cell tower REITs is they have exhibited much less inflationary pressure in terms of operating costs and development versus other forms of real estate. The average construction of a cell tower is less than $500,000 and much of the maintenance is contractually covered by the tenants. Other operating costs are likewise relatively light including ground rent, in cases when the land is not directly owned, and monitoring equipment.
With so many attractive attributes to the cell tower business, the question may be asked as to whether such a differentiated sector is real estate at all. Invesco Real Estate believes that cell tower REITs are intrinsically real estate for many reasons. Cell tower businesses share many aspects to other types of real estate. The process for the business model involves siting, property acquisition, zoning, construction and a source of value driven by tenant-generated rents. Cell towers are likewise permanent structures situated on land sites and supported by a fixed foundation. The Internal Revenue Service and the Treasury Department have determined that cell towers qualify as real estate and can organize themselves as REITs. The largest cell tower operators in the U.S. have all structured themselves as REITs and began doing so more than a decade ago.
Invesco Real Estate believes that cell tower REITs should exhibit a strong pattern of structural growth for many years to come. The business model has strong demand drivers stemming from the way we consume data and use communications equipment. With the parabolic yearly increase in data consumption, cell tower REITs provide an essential service to society, and telecommunications companies could not be successful without them. 5G is opening a new window for consumers to receive faster speeds and for more complex content. And that should allow for relatively inelastic demand for the cell towers. Cell tower REITs, which are sometimes grouped among “specialty” property sectors, are amongst the largest listed real estate companies in the world. They have generated outsized returns versus broader equity markets, the S&P 500 and REITs, based on the FTSE Nareit All Equity REITS Index over the past twenty years as of March 31, 2023. They may have a path to adding value in listed real estate securities moving forward.
Reprinted by permission from the Pension Real Estate Association.
1 Source: FTSE EPRA Nareit as of March 31, 2023
2 Source: FTSE Nareit as of March 31, 2023
3 Source: Bloomberg as of March 31, 2023.
4 Sources: FTSE Nareit and Bloomberg as of March 31, 2023.
5 Source: Morningstar. Past performance is not a guarantee of future returns.
Darin Turner is Managing Director and Chief Investment Officer, Listed Real Assets, North America at Invesco Real Estate.
This article has been prepared solely for informational purposes and is not to be construed as investment advice or an offer or a solicitation for the purchase or sale of any financial instrument, property, or investment. It is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. The information contained herein reflects the views of the author(s) at the time the article was prepared and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing or changes occurring after the date the article was prepared.