The rise of artificial intelligence (AI) has been all the hype this year, with many pockets of the market benefitting such as semiconductors and software. Growth stocks have led the rally, but the red-hot tech sector may be due for a breather after a blazing start to 2023. 

We still want to take advantage of the bullish AI theme, but with large-cap tech extended in the short-term, we need to look elsewhere. A solid approach is to target equities that still have substantial room for appreciation but also generate income.

A Lucrative Method to Gain Exposure to AI

Demand has been booming lately for AI-focused data center chips. One overlooked area of the market that can take advantage of the move are real estate investment trusts (REITs). Specifically, data center REITs provide the storage capability and computing resources that assist AI-related companies in processing large data sets.

Like growth stocks, REITs were decimated last year as the Fed embarked upon an aggressive rate-hiking scheme. Combined with prospects of an impending economic slowdown, REITs suffered their worst year in more than a decade.

This has created a phenomenal opportunity to buy these undervalued, oft-forgotten investment vehicles, as the path of future interest rates has reversed course. Despite the Fed’s best attempts to convince markets that several more rate hikes lie ahead, the recent pause signals that we are likely close to the end of this hiking cycle (possibly one or two more hikes), with rates set to fall in the coming years.

All else being equal, lower interest rates tend to increase the value of properties and decrease REIT borrowing costs. Furthermore, lower rates make the relatively high dividend yields generated by REITs more attractive, increasing their appeal to income-seeking investors.

Advantages of REITs

Adding these incoming-producing investments can result in significant advantages over traditional real estate investing including increased liquidity, greater diversification, tax benefits and potentially higher returns with lower risk.

Real estate investment trusts either own or manage income-producing real estate, normally through directly investing in properties or the mortgages on those properties. The IRS mandates that REITs must pay out 90% of their taxable income to shareholders. This typically translates into much higher dividends than your average S&P 500 stock.

The Zacks REIT and Equity Trust – Other industry is currently ranked in the top 50% out of approximately 250 Zacks Ranked Industries. This group remains relatively undervalued:

Image Source: Zacks Investment Research

Let’s take a closer look at an individual REIT within this industry group.

Iron Mountain, Inc. (IRM Quick QuoteIRM - Free Report)

Iron Mountain is a global leader in innovative storage, data center infrastructure, asset lifecycle management and information management services. The company offers digital transformation, secure records storage, and art storage and logistics, operating as a real estate investment trust.

Iron Mountain enjoys a steady stream of recurring revenues from storage rental and related services. Storage rental revenues are generated through fixed periodic rental charges (typically on a monthly basis) for data storage. Services revenues comprise charges for related core service activities and a wide array of complementary products and services. Iron Mountain is supplementing the storage performance with expansion in its faster-growing business in the data center space.

The company boasts a customer retention rate of approximately 98%. IRM, a member of the S&P 500, serves more than 225,000 customers from various industries through approximately 1,400 facilities. As we can see, earnings and revenue growth have remained steady:

Image Source: Zacks Investment Research

Iron Mountain’s global data center portfolio is well-positioned to benefit from high demand for the inter-connected data center space on the back of rising enterprise cloud adoption. Total revenues are projected to increase 8.2% year-over-year in 2023.

Recent Earnings and Future Estimates

Iron Mountain has surpassed earnings estimates in each of the last four quarters, with an average beat of 2.93% over that timeframe. The data center REIT most recently reported first-quarter funds from operations (FFO) back in May of $0.97/share, surpassing the $0.93/share Zacks Consensus Estimate. The figure grew 6.6% from the year-ago period.

For the full year, analysts expect IRM to deliver earnings of $3.96/share, translating to growth of 4.2% versus last year.

Final Thoughts

REITs not only offer above-average yields, but also the potential for future price appreciation.

Iron Mountain has steadily increased its quarterly dividend over the past thirteen years. IRM currently pays a $2.47 (3.99%) dividend. A consistently rising dividend trend subtly reveals a company’s progress and is one of the best indicators of a healthy, growing enterprise.

Make sure to keep an eye on IRM as well as the general data center REIT space as the group looks primed for a period of outperformance.