Digital real estate’s fundraising appeal cannot be ignored

In a market fraught with doubts about the necessity of offices, the future appeal of big cities and other existential threats to the real estate status quo, one certainty that has emerged during the covid era is the appeal of digital assets.

Digital Colony gave further credence to that fact this week. The post-merger amalgamation of private equity real estate manager Colony Capital and infrastructure specialist Digital Bridge has raised $4.1 billion for its second digital asset-focused fund, which recently held its first close, per Bloomberg. This puts the firm well on its way to its $6 billion target for Digital Colony Partners II not even two years after closing its pioneering first fund on $4.05 billion. Digital Colony declined to comment on its ongoing fundraise.

And this fundraising is not just a case of the already subscribed looking for more. Already, the firm has added a handful of notable new investors for its second vehicle, including the New Jersey Division of Investment and the Virginia Retirement System. They committed $100 million each. Also, shortly after Digital Colony Partners I closed in the summer of 2019, Wafra – the Kuwaiti sovereign wealth-investor-turned-manager – bought a minority stake in the Digital Colony platform for $400 million. Meanwhile, returning investors Teachers’ Retirement System of Texas and Employees’ Retirement System of Texas both increased their ticket sizes by 25 percent, to $250 million and $125 million, respectively.

This continued rush of institutional capital toward the digitally focused strategy gives further validation to Colony’s decision to walk away from traditional real estate entirely. It also shows that investment in digital assets can be done at a private market scale.

Public markets have favored digital assets for years. Four of the five biggest REITs by market cap fall into the digital bucket: cell tower owners American Tower and Crown Communications are valued at upwards of $100 billion and $70 billion, respectively, while data center operators Equinix and Digital Realty are valued at $67 billion and $41 billion. With listed platforms holding such an advantage in capitalization, not to mention operational expertise, private market managers have shied away from the sector. But doing so has left a void in the market that Digital Colony has seen fit to fill.

While digital REITs have become dominant forces in their respective fields – housing servers for large cloud storage providers and carrying signals for the biggest telecom conglomerates – they are still subject to the daily fluctuation of market sentiment. And in favorable sectors, such as data centers and towers, that can mean paying a premium to a trust’s net asset values but having no protection against volatility.

Still, many institutional investors are scaling up their exposure to REITs precisely because there are so few opportunities to access growth sectors such as data centers and cell towers in the unlisted world.

Some diversified private managers have slowly started adding data centers to their strategies. BentallGreenOak committed €140 million to Bulk Infrastructure Holding, a Nordic developer focused on data centers, fiber networks and logistics, at the end of last year. Alternative real estate manager Harrison Street has acquired one-off colocation centers through joint ventures with a sector specialist. But such properties account for just a sliver of institutional portfolios.

There are undoubtedly high barriers to enter the digital real estate sector, and the partnership between a traditional manager such as Colony and a specialist like Digital Bridge will not be readily recreated. But the growing appeal of Digital Colony’s offerings show there is a strong capital market waiting for groups that do find ways to access this emerging sector.