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Digital Core REIT is Offering a 4.75% Distribution Yield: Is This Sustainable?

·5-min read
Digital Core REIT
Digital Core REIT

The local bourse is enjoying a breath of fresh air in the form of new IPOs.

Hot on the heels of last week’s IPO of Daiwa House Logistics Trust (SGX: DHLU) comes Singapore’s second REIT IPO this year.

Digital Core REIT, or DCR, is a pure-play data centre REIT offering a total of 267 million units at US$0.88 per unit to raise total gross proceeds of US$977 million.

The REIT will have an initial portfolio of 10 data centres located in both the US and Canada worth around US$1.4 billion.

This will be the second pure-play data centre REIT to be listed on the Singapore Exchange after Keppel DC REIT (SGX: AJBU).

The sponsor for the REIT is Digital Realty Trust (NYSE: DLR), or DRT, which is itself a REIT and the largest owner, operator and developer of data centres worldwide.

DCR offers an enticing distribution yield of 4.75% for its forecast year 2022 ended 31 December 2022.

While the yield is attractive, investors may wonder if it is sustainable.

Does DCR have attractive characteristics that help to support the REIT’s distribution per unit (DPU) and can allow it to grow its portfolio over time?

Attractive operating metrics

The REIT’s initial portfolio has attractive operating metrics.

The weighted average lease expiry is 6.2 years, offering stability and certainty of rental income, while the occupancy rate is 100% as of 30 June 2021.

DCR also has a high-quality customer base comprising leading cloud providers, social media platforms, and IT solution providers.

The 10 data centres support 12 customers, of which one, a Fortune 50 software company, contributes 36% of base rental income.

Though the customers cannot be named due to confidentiality reasons, DRT did state that its top 20 customers based on annual recurring revenue include IBM (NYSE: IBM), Meta Platforms (NASDAQ: FB), LinkedIn (a unit of Microsoft (NASDAQ: MSFT)), and AT&T (NYSE: T).

Close to all the leases have built-in rental escalation clauses ranging from 1% to 3%, allowing for organic rental income growth.

Around 85% of the IPO portfolio’s net rentable square feet (NRSF) is on a triple-net lease structure, whereby the lessee or customer pays for maintenance, insurance, and property taxes, providing the REIT with adequate protection against rises in operating expenses.

A reputable sponsor

DRT is a reputable sponsor with a long operating history.

The REIT, which was listed on the New York Stock Exchange in 2004, owns a whopping 290 data centres and has a market capitalisation of around US$44 billion.

DRT is the sixth-largest publicly traded US REIT, boasting more than 4,000 customers, and has around 7.6 million square feet of data centres under development.

The data centre operator employs more than 3,000 full-time employees and also serves 47 markets across 24 countries, showcasing its scale and breadth of coverage.

DCR’s initial portfolio is also fully integrated into the sponsor’s data centre platform, PlatformDIGITAL, which assists customers in scaling up their digital businesses.

The presence of a reputable sponsor bodes well for the future of the REIT.

A pipeline of assets available

No discussion is complete without considering the REIT’s future growth prospects.

The sponsor for DCR has a pipeline of data centre assets worth around US$15 billion that can be injected into the REIT in the future.

This pipeline is under a right-of-first-refusal (ROFR), which means that DRT will offer the assets to DCR first and can only be marketed to external parties if DCR rejects the deal.

In addition, DRT has a development pipeline totalling around US$5 billion spread out across the US, Latin America, and the Asia-Pacific region that may be injected into DCR once stabilised.

Another attractive fact is that the REIT is expected to list with aggregate leverage of just 27%, giving it a debt headroom of US$596 million before hitting the 50% gearing threshold.

With the average asset size within the portfolio being US$144 million, this means that the REIT can undertake at least one acquisition to boost its portfolio asset size by 10% before reaching the 35% gearing level.

By comparison, Keppel DC REIT has aggregate leverage of 35.1% as of 30 September 2021.

Sustained demand for data centres

Demand for digital solutions has accelerated over the past 20 months, and the presence of numerous technology trends such as artificial intelligence, cloud computing, and the growth of online streaming has helped to fuel this surge.

The REIT’s customer retention rate is 96% and 68.5% of the IPO portfolio is focused on the attractive hyperscale segment that is witnessing huge demand.

Get Smart: An array of attractive attributes

DCR enjoys an array of attractive features.

The REIT boasts a portfolio of properties that should enjoy sustained demand over the medium term, is backed by a reputable sponsor and has a ready pipeline of assets on ROFR that can be injected for future growth.

The REIT is projecting a DPU growth of 5.3% for the fiscal year 2023 to US$0.044 per unit, which provides a distribution yield of 5% based on the IPO price of US$0.88.

The closing date for application is 2 December at noon and DCR starts trading on 6 December at 2 p.m.

At the Smart Dividend Portfolio, we are fans of REITs.

In fact, we have selected nine high-quality REITs for the portfolio and are always on the hunt for more.

As we cast our eyes out into 2022, the future looks bright for Singapore’s status as a REITs hub with the addition of more choices than ever before.

Picking the right investment matters.

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Disclaimer: Royston Yang owns shares of Keppel DC REIT and Meta Platforms.

The post Digital Core REIT is Offering a 4.75% Distribution Yield: Is This Sustainable? appeared first on The Smart Investor.

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