Not too long ago, mobile phones were considered a discretionary item. By today’s standards, the initial technology was rudimentary, and those who had them often left them in the glovebox of a car in case they needed to call for a tow.
Times have changed. Around 2007, the mobile phone got “smart” and since then has emerged as a vital tool for our daily lives. It has evolved from a simple phone, to a talk and text device, to a multifunctional necessity. Today’s phones are used as mini-supercomputers.
As our phones and their capabilities have grown and evolved, so too have the mobile networks upon which they rely. The first generation of wireless networks (1G) was introduced in the 1980s and supported voice-only calls, if you could get a signal at all. The 1990s ushered in the 2G era and effectively took cell phones from analog to digital communications, as well as introducing call and text encryption, and data services such as SMS and picture messages. In 1998, 3G networks ushered in faster data-transmission speeds, so you could use your cell phone in more data-demanding ways, such as video calling and mobile internet access. The 4G networks introduced in 2008 support mobile web access like 3G did, as well as gaming services, HD mobile TV, video conferencing, 3D TV, and other features that demand high speeds. Now wireless carriers, such as AT&T, T-Mobile USA, Verizon Communications and others, are in the process of rolling out 5G, the fifth generation of wireless networks.
When we pick up our mobile phones, we expect them to work without fail, all the time. For that to happen, we need a massive network of digital infrastructure assets to send and receive signals to and from our phones, as well as all other connected devices. Cell towers are a key component of the wireless networks that keep us connected. That connectivity has become utility-like in nature and ranks with necessities such as water, gas and electricity.
Cell towers are structures that support radios, computerized switching equipment and antennas for receiving and transmitting the radio frequency signals to and from our phones. They are usually very tall, typically 150 feet to 270 feet, and equipment on the tower is positioned at strategic heights and angles so the signals can adequately cover a predetermined area. Wireless carriers typically rent space on these structures, so they can put their equipment on them and create wireless coverage within their networks. In this respect, from an owner’s perspective, cell towers are similar to commercial real estate. You might own a tower that has space for four tenants, and ideally, you would like to lease all the space on that tower. Cell-tower leases are much like traditional commercial real estate leases. Initial lease terms are often five to 10 years and usually include multiple renewal periods that are often in five-year increments. Annual rent increases are also often part of the lease. So, a new lease might be structured for an initial period of 10 years, with five five-year renewal periods and 2.5 percent annual rent increases. This would give a cell-tower owner a 35-year time horizon from which to predict future cash flows.
Right now you might be thinking, 35 years sounds good, but they might not renew the lease. That’s true, but it typically isn’t the case. Historically, renewal rates have generally hovered around 98 percent and were relatively stable during the 2008–2009 global financial crisis. The same has held true throughout the first half of 2020 and the COVID-19 pandemic. Wireless carriers’ networks are very sophisticated, and their radio equipment is strategically placed on towers — as well as rooftops, buildings, water towers, billboards and other elevated structures — to provide a sophisticated web of coverage and connectivity. Vacating a tower and removing equipment would likely result in a “dead zone,” or gap in the company’s network coverage, as well as incurring significant labor and equipment costs. In the telecommunications business, there is a saying: Coverage is king. It is often the reason many people switch from one carrier to another, as users become frustrated with dead zones, dropped calls and inefficient data services. The carriers want to do everything they can to retain customers and get new customers. They do that by maintaining existing cell sites while constantly expanding to new sites to create the best coverage models. For that reason, tenants on towers often stay in place for a very long time, earning the reputation as “sticky” tenants.
But the major national wireless carriers are not the only tenants on towers. Other potential tenants include regional and rural carriers, government entities, police and fire, radio and television broadcasters, municipalities, and more.
AT&T, Verizon, T-Mobile, Sprint Corp. and United States Cellular Corp. were considered the top five carriers, though a $26.5 billion merger deal between T-Mobile and Sprint has created the so-called New T-Mobile, an organization expected to ramp-up combined capital investments of about $40 billion over the next three years to bolster its network and business lines.
5G deployments are also a major catalyst for growth in the cell-tower leasing environment. All of the major carriers continue to allocate tens of billions of dollars each to further expand and develop their networks, providing tower owners with potential growth opportunities. When carriers upgrade 4G network components on towers with new 5G-compatible equipment, lease modifications are usually part of the deal, typically including increased rental rates and term extensions. As a matter of clarification, the same cell towers that served 1G and 2G are likely the same towers that serve 4G today and 5G tomorrow. Think of the tower as a vertical piece of real estate that is positioned in a strategic location. The tenant may have its 4G equipment on the tower today and decide at some point to upgrade that equipment to 5G. The cost and effort to make those upgrades are borne by the tenant, not the tower owner.
Companies are racing to establish the fastest or largest 5G network. Countries are also competing to be the first to deploy fully functional nationwide 5G. This new technology is expected to fuel other transformative new technologies, not only for consumers but also for businesses, infrastructure and defense applications. Intel predicts by 2025 more than 1 billion 5G devices will be in use, and by 2035, 5G will create about $10 trillion in economic output. The amount of change brought about by 5G is expected to rival the first three industrial revolutions — when people went from using their hands, to machines, to mass manufacturing, to living in a digital world. In addition to blazing upload and download speeds, 5G is expected to have greater bandwidth, meaning it can handle many more connected devices than previous networks. It will enable devices such as virtual reality, self-driving cars, wearables and new technologies to come. 5G is also expected to reduce latency — the time it takes for a cell phone (or other connected devices) to make a request from a server and get a response — to virtually zero. And it will make communication with cloud platforms (Amazon Web Services, Google Cloud, etc.) faster and easier.
But this capability comes with a trade-off. For the most part, 5G signals tend not to travel as far as 4G signals. A 4G signal on a cell tower may have a range of several miles, but the hyper-speedy 5G signals we’re all waiting for might only travel a few thousand feet. As such, it’s likely massive telecom infrastructure deployment and “densification” of wireless networks will be required to make 5G a reality. That likely means more cell sites, whether they be on traditional cell-tower structures, light poles, water towers, billboards, rooftops, telephone poles, sides of buildings, and so on. Wireless carriers are committing tens of billions of dollars each year to fortify and expand these networks.
Once you own a cell tower, ongoing maintenance is generally minimal. Operating expenses are usually low and include what is called TUMI: taxes, utilities, maintenance and insurance. In some cases, a ground lease expense may apply as well, if you don’t own the land under the tower. Those expenses are relatively predictable and tend not to fluctuate very much over time. Ongoing capital expenditures are also generally very minimal over the life of the asset. You basically own what is often referred to as “steel in the air.” Operational maintenance typically includes keeping the FAA-required lighting at the top of the structure running (when required), maintaining the fencing, keeping the area under the tower free of debris and vegetation, and maintaining a clear path on any access roads. Finally, tenant improvement costs are usually minimal or nonexistent when adding a tenant to a tower. When a new tenant comes onto the tower, it is responsible for costs associated with adding its equipment, not the tower owner.
For the most part, towers don’t require someone onsite to operate, and there’s no public foot traffic that needs to be supported. Relative to large commercial real estate structures, towers are pretty simple with regard to operations and maintenance. Long-term leases, annual rent escalators, and sticky, creditworthy tenants lead to relatively stable and predictable revenue streams. Combine that with minimal capital expenses, tenant improvements and operating expenses, and you can see why cell-tower ownership is often such a high-margin business.
Cell-tower owners certainly seem to have the wind at their backs. Wireless data consumption is practically doubling every two years. It seems that everywhere you turn, more devices are being connected to the internet. New technologies, such as artificial intelligence, virtual reality and autonomous cars, will likely rely on highly sophisticated data streams and an even greater number of cell sites. And 5G, which is only beginning its implementation, is expected to bring connectivity and technology to a new era. These, and other factors, will likely require massive investments to expand communications infrastructure capacity over the next decade, and cell-tower owners appear to be well positioned to benefit from these trends.
Jim Condon is president of Strategic Capital Fund Management.