Better Buy: Keppel DC REIT Vs Digital Core REIT

The REIT sector has faced strong headwinds in the past two years from rising inflation and a surge in interest rates.

Income investors are worried that REITs may have to drop their distribution per unit (DPU) as finance and operating costs increase.

Industrial REITs, however, have held up better than most other REIT sub-sectors as demand for e-commerce remains strong.

In particular, data centre REITs demonstrated resilience as technology companies need vast amounts of storage space with the explosion in digitalisation and electronic device usage.

Keppel DC REIT (SGX: AJBU) and Digital Core REIT (SGX: DCRU) are beneficiaries of this trend.

Both REITs are pure data centre REITs but we compare each REIT on various metrics to determine which is the better buy.

Portfolio composition

First, we look at the composition of each REIT’s portfolio.

Keppel DC REIT has nearly double the number of data centres compared with Digital Core REIT.

The valuation of Keppel DC REIT’s properties, at S$3.7 billion, is also nearly double that of Digital Core REIT.

Moreover, Keppel DC REIT’s properties can be found in nine countries whereas Digital Core REIT is only present in four countries – Germany, the US, Canada, and Japan.

Winner: Keppel DC REIT

Financial metrics

Digital Core REIT had a tough time in 2023 because of the bankruptcy of one of its key tenants.

Luckily, the data centre REIT managed to resolve this bankruptcy through a series of transactions in which it sold off the troubled data centres and acquired additional data centres with the proceeds.

Because of this disruption in rental income, gross revenue and net property income (NPI) fell year-on-year.

Digital Core REIT’s DPU also fell by 7% year on year to US$0.037.

Keppel DC REIT reported a year-on-year improvement in both revenue and NPI as organic rental growth and acquisitions contributed to the increase.

However, the REIT also saw its DPU fall from 2022 levels because of a provision made for unpaid rental from one of its tenants, Bluesea.

As a result, its DPU tumbled by 8.1% year on year to S$0.09383.

Keppel DC REIT is still the winner in this category as it managed to post an increase in its top line as opposed to a decline for Digital Core REIT.

Winner: Keppel DC REIT

Debt metrics

Moving on to each REIT’s debt metrics, we observe that Digital Core REIT has a lower gearing ratio of 33.5% compared to Keppel DC REIT’s 37.4%.

However, Digital Core REIT has a higher cost of debt and a lower interest coverage ratio.

Both REITs are about on par in having close to three-quarters of their debt on fixed rates to mitigate the rise in interest rates.

In the current rising interest rate environment, the REIT with the lower cost of debt has a clear advantage.

Winner: Keppel DC REIT

Operating metrics

Both data centre REITs saw their occupancy rates hover at high levels above 95%, with Keppel DC REIT’s occupancy coming in slightly higher at 98.3% versus Digital Core REIT’s 97%.

There was, however, a large difference when it came to each REIT’s weighted average lease expiry (WALE).

Keppel DC REIT signed long leases with its tenants, resulting in a WALE of 7.6 years which was more than twice as long as Digital Core REIT’s 2.8 years.

Winner: Keppel DC REIT

Valuation

Next, we compare each REIT’s valuation to see which provides better value.

Digital Core REIT sported a price-to-book (P/B) ratio of just 0.65 times, possibly due to pessimism over its recent customer bankruptcy and the complicated structure of its series of transactions to resolve this problem.

In contrast, Keppel DC REIT’s P/B ratio stood at a lofty 1.27 times as the REIT’s unit price came in at a premium to the value of its assets.

Investors may be looking at a bargain when it comes to Digital Core REIT but consider the REIT’s other attributes when making their decision.

Winner: Digital Core REIT

Distribution yield

Finally, we turn to each REIT’s distribution yield.

Digital Core REIT has a higher distribution yield than Keppel DC REIT at 6.2% versus the latter’s 5.5%.

Income investors, however, need to consider the sustainability of each REIT’s DPU rather than just look at the headline yield.

Winner: Digital Core REIT

Get Smart: Keppel DC REIT takes the cake

Overall, Keppel DC REIT wins by having more positive attributes than Digital Core REIT.

However, investors should also consider two other metrics – each REIT’s sponsor along with the sponsor’s pipeline of assets.

Keppel DC REIT has a strong sponsor in blue-chip asset manager Keppel Ltd (SGX: BN4) while Digital Core REIT’s sponsor is an established data centre REIT Digital Realty Trust (NYSE: DLR) listed in the US.

Keppel Ltd has a pipeline of more than S$2 billion of data centre assets that can be injected into Keppel DC REIT.

Digital Realty Trust has an impressive pipeline of more than US$15 billion of assets located across the globe that may be injected into Digital Core REIT in the future.

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Disclosure: Royston Yang owns shares of both Keppel DC REIT and Digital Core REIT.

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