Introduction of Digital Core REIT

Digital Core REIT is one of the largest IPO that is expected to list on the Singapore Stock Exchange (SGX) on 6^th December 2021. The Offering Price is USD 0.88 per unit. The Trustee is Perpetual (Asia) Limited and the Sponsor is Digital Realty Trust L.P. There are a total of 267 m units offered to public and institutional investors – 13.3m units for the public tranche and a placement tranche of 253.7m units.

Digital Core REIT will own 90% of the properties while the Sponsor will own the remaining 10%. The Sponsor will continue to own a 38.1% direct stake. The REIT intends to raise gross proceeds of US$977m from the Offering.

There is a long-term track record of portfolio occupancy averaging 99%. The customer retention rate has been high at 96% since 2012.

Tailwind of data centre

The data center industry is benefiting from demands from digital transformation. With enterprise adoption of hybrid IT public and private cloud computing. There is accelerating digitisation of economic activity. 

Emerging technologies such as: 

• Artificial Intelligence
• Internet of Things 
• 5G technology 
• Edge computing 

These drive exponential growth of data generated, transmitted, processed, analysed, consumed and stored. There is strong growth in streaming, social media, cloud computing, enterprise modernisation and e-commerce. All these are further accelerated due to the COVID-19 pandemic.

The data centre industry creates “sticky” customer relationships with high customer retention rates. Once the client onboards, the cost of switching will be high. It costs approximately US$15 – 30m to deploy a new 1.125 megawatt (MW) data centre. The cost to migrate a 1 MW data centre to a new facility is approximately US$15 – 20m. Hence, the retention rate is stable over the long term.

Source: Page 34 of 644 of Prospectus

According to Market Research Future’s research, the Global Hybrid Cloud Market is said to be growing at a compound annual growth rate (CAGR) of 22% reaching US$173b in 2025. Cloud spending is growing at a CAGR of 26% which will reach $482b in 2022 .

Analysis of the property portfolio

Source: Page 27 of 644 of Prospectus

Digital Core REIT’s present portfolio consists of 10 freehold data centers within the U.S. and Canada. It has an appraised valuation of USD 1.4b. Digital Core REIT has 100% occupancy rate for all 10 properties.

Some of the properties such as 1500 Space Park Drive, 2401 Walsh Avenue, 200 North Nash Street and 317 Gough Road were built between 1970 – 1980. They were refurbished between 1999 – 2015. All 10 properties span over a total 1,209,163 square feet, with an average appraised valuation cap rate of 4.25%.

Weighted Average Lease Expiry (WALE)

The weighted average lease expiry term is 6.2 years. Close to 100% of existing lease agreements enable annual rental rate escalations of an average 2% per year. Customers generally sign 5 to 15 years lease agreements. Anchor customers sign longer than 10 years in duration. This provides predictable long-term cash flow for Digital Core REIT. 

89.3% of the portfolio was renewed in 2017. The total portfolio has a staggered lease maturity profile. This gives time to look for new customers in the event existing ones choose not to renew the lease. Furthermore, it provides for stable and recurring cash flow, and ensures that the payout will be stable for the foreseeable future.

Source: page 38 of 644 of Prospectus

Digital Core REIT’s tenants’ profile

Digital Realty, the Sponsor has disclosed their top 20 customers portfolio. I am guessing that its top ranked customer is Microsoft. Digital Core REIT will be able to access the Sponsor’s mix of customers. They span over many locations and geographies.

Source: Page 37 of 644 of Prospectus

Strength of sponsor

Digital Realty (NYSE:DLR) is the Sponsor of Digital Core REIT. It is the largest owner, developer, and acquirer of data centres globally. This allows Digital Core REIT to invest in the Sponsor’s investment pipeline of over US$15b. The Sponsor provides Global Right of First Refusal to Digital Core REIT. This allows Digital Core REIT to inject and grow its assets that fit the investment mandate.

Their top 20 customers have on average over 40 deployments across 291 facilities throughout 24 countries. They are the 6^th largest U.S. listed REIT with a market capitalization of US$44b. They serve more than 4000+ customers. Digital Reality has been listed since 2004 and owns more than 290 data centres. 

Digital Core REIT’s financials

Source: Digital Core REIT’s Product Highlight Sheet Page 4 of 11 P&L and Balance Sheet.

Digital Core REIT offers an attractive distribution yield of 4.75% for Year 2022 and 5% for Year 2023. The appraised valuation of the assets was US$1.441b. The average capitalization rate was 4.25%. The net property income for 2022 is US$66.86m which represents a property yield of 4.6%. 

Distributions to unitholders will be computed based on 100.0% of annual distributable income for the period from the Listing Date to the end of 2023. Thereafter, at least 90.0% of its annual distributable income is distributed for each financial year. The first distribution will be from June 2022.

The gearing ratio is at approximately 27.0% which is much lower than Keppel DC REIT’s gearing ratio of 35.1% in 2021. With the low gearing ratio, it means there is sufficient room for Digital Core REIT to raise funds via debt. This allows the REIT to acquire more properties. 

Referring to the below image, a 35%, 45% and 50% gearing will allow for US$ 160m, US$424m and US$596m of debt headroom for growth respectively. For acquisitions, Digital Realty will co-invest with its REIT arm. The sponsor will hold 10% of the asset while the REIT with the remaining 90%.

Source: Page 4 of 644 of Prospectus

Not just stable but has a growth story

The Sponsor has a pipeline of projects under various stages of construction. This provides Digital Core REIT a significant opportunity to get newly-built properties. As of June 2021, the Sponsor’s global development pipeline has US$5b assets when completed. This comprises 220 MW across 20 metros in EMEA and APAC.

As Digital Core REIT’s present portfolio value based on 90% interest is worth only US$ 1.3b, there is ample room for the REIT to grow though asset injections given its Sponsor’s US$ 15b development pipeline as seen in the below image.

Source: 41 of 644 of Prospectus

Potential risk for unitholders

While there is a potential to grow the portfolio to over US$15b, unitholders need to be aware such growth could be funded through rights issuance which may result in shareholding dilution if the rights issues are not subscribed. Unitholders would need to have the cash to take up the rights issues. 

Keppel DC REIT has a fixed interest rate for the next 3 years. Whereas Digital Core REIT uses a floating interest rate. Rising interest rates may result in an increase in financing expenses, which is detrimental to Keppel DC REIT.

Redevelopment works may affect operations which will reduce the collection of rental income. There are risks of environmental costs during development or reinstatement of building. That said, Digital CORE REIT does not expect to incur any material capital expenditure for 2022 and 2023.

To sum it all up

I like what I see from the prospectus. I am going to look at the price when the REIT lists in the open market. This is one of the REITs which I believe it will be interesting to include in a dividend growth portfolio. I like the industry, the strength of the Sponsor and the interest of the REIT aligns with the Sponsor. 

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