Upcoming pure-play data centre REIT: Digital Core REIT IPO

Digital Core REIT, a US real estate investment trust with a data centre portfolio, has filed a preliminary prospectus for its IPO on 22 November 2021. The offering comes with the issuance of 267,034,000 units at an indicative price of USD0.88 per unit. I read the prospectus so you don’t have to and here’s what you need to know.

What is Digital Core REIT?

According to the prelim prospectus, Digital Core REIT is a Singapore REIT (S-REIT) established with the principal investment strategy of investing, directly or indirectly, in a diversified portfolio of stabilised income-producing real estate assets located globally which are used primarily for data centre purposes, as well as assets necessary to support the digital economy.

Digital Core REIT seeks to create long-term, sustainable value for all stakeholders through ownership and operation of a stabilised and diversified portfolio of mission-critical data centre facilities concentrated in select global markets. Digital Core REIT will be the exclusive S-REIT vehicle sponsored by Digital Realty, the largest global provider of cloud- and carrier-neutral data centre, colocation and interconnection solutions.

About the sponsor: Digital Realty

The sponsor Digital Realty is one of the largest listed US REITs with a well-established track record and public market expertise in the data centre industry. It is one of the 10 largest US-listed REITS, with an equity market capitalisation of approximately US$44b and a total enterprise value of US$58b.

Being the largest owner, operator, developer, and acquirer of data centres globally, it has deep and specialised knowledge in the end-to-end value chain of data centre operation which would be extremely advantageous to the future growth of the Digital Core REIT. Not only could the Sponsor provide a steady industry-leading acquisition pipeline for the Digital Core REIT, the REIT also could leverage the Sponsor’s track record to access multiple capital sources to grow its portfolio and deliver shareholder returns.

According to the prospectus, Digital Realty also intends to co-invest with Digital Core REIT for all future acquisitions, holding 10% of the asset and the REIT holding 90%. This co-investment would help to align the interests of the REIT and its sponsor in the long term and address potential conflict of interest between the two REITs.

IPO portfolio summary

  • Digital Core REIT IPO portfolio comprises 10 institutional quality data centres in the top-tier cities in US and Canada with an aggregate valuation of US$1.4 billion. Northern Virignia and Northern California where majority of the assets are located are the #1 and #2 largest data centre markets in the US. Assets are also 100% freehold, making it the only 100% freehold data centre SREIT
Overview of Digital Core REIT’s IPO portfolio (Source: REIT IPO prelim prospectus)
  • Digital Core REIT will indirectly own a 90% interest in each of the 10 properties within the IPO portfolio through its 100% indirect ownership of the common shared of the Parent US REIT, which in turn owns a 90% ownership in the US JVs. It also has 100% ownership of the ordinary shares of Singapore Sub 3, which in turn has a 90% ownership interest in the Canadian JV, while Digital Realty as the Sponsor Investor retains a 10% stake in each of the JVs. By virtue of the Sponsor’s continuing involvement and ownership interest, the assets would be integrated into Digital Realty’s global platform and the REIT could maximise the value of its assets.
Structure of the REIT showing relationships between related parties (Source: REIT IPO prelim prospectus)
  • Digital Core REIT will be able to access the Sponsor’s high-quality and diversified mix of customers across multiple locations and geographies. Top customers and tenants consist of Fortune Global 500 cloud companies, social media platforms, and IT solution providers.
Top 20 customers of Digital Realty at a glance (Source: REIT IPO prelim prospectus)
  • Long weighted average remaining lease term of 6.2 and 7.7 years with no meaningful lease expirations in 2022 or 2023. Customers generally sign 5 to 15 year lease agreements which provides predictable long-term cashflow for the REIT. With a well-staggered lease maturity profile, the REIT would also have ample time to source and on-board new customers for future expiring leases.
Well-staggered WALE profile of the IPO portfolio (Source: REIT IPO prelim prospectus)
  • IPO portfolio has a long term track record of stabilised portfolio occupancy of 99.4% since 2012. Current portfolio occupancy is at 100% which is underpinned by historical high customer retention rate of 95.8%. Reason for this is the high initial capex incurred by the customer and high switching costs involved. Fun fact: it costs approximately US$15-30m to deploy a new 1.125MW data centre and approximately US$15-20m to migrate a 1MW data centre to a new facility.
  • 100% of lease agreements contain contractual annual cash rental rate escalations ranging from 1.0% to 3.0% with a weighted average of approximately 2%, while approximately 85% of the IPO portfolio is leased on a triple net-lease structure. In a triple net lease, the lessee pays for rent and property-related expenses such as property tax, insurance and data to day maintenanc which helps the REIT to provide some insulation against opex growth.
  • At listing date, the IPO portfolio is expected to have an aggregate leverage of approximately 27%, significantly below peers and the SREIT gearing limit of 50%. This leaves plenty of debt headroom for the REIT to scale and fund post-IPO investments on attractive terms.
Conservative capital structure provides significant debt headroom for future acquisitions (Source: REIT IPO prelim prospectus)

Other interesting things to note: Alignment of Sponsor and REIT

Digital Realty will be the largest unitholder of the Digital Core REIT with approximately 39% ownership stake (US$390m) at listing date assuming the over-allotment option is not exercised. The Sponsor will also retain 10% direct ownership stake in the IPO properties. The Manager and Property Managers will be 100% owned by the Sponsor, and the Manager will receive 100% of its compensation in units for the Forecast Year 2022 and Projection Year 2023.

As the largest global owner and operator of data centres with a total of 291 data centres across Americas, EMEA, and the Asia Pacific, Digital Realty has a large pool of stabilised-incoming producing assets that Digital Core REIT is expected to benefit from through the global right of first refusal (ROFR) granted by the Sponsor.

These are some ways that show the commitment of Digital Realty to the growth and success of Digital Core REIT, and also helps to align the interest of the Sponsor and unitholders. However, the issue of potential overlapping investment mandates between Digital Core REIT and Digital Realty still hangs in the air and it remains to be seen how the Sponsor will ultimately support the growth of Digital Core REIT.

Indicative timetable for the offering

At the time of publication, Digital Core REIT has yet to release details on the timeline for the IPO application. I will update again when the information is announced.

TLDR: Why might Digital Core REIT be an attractive investment?

  • Exclusive focus on data centre industry which has benefited greatly from robust demand driven by digital transformation
  • High-quality, mission critical portfolio across top data centre markets
  • Stable and resilient portfolio with high quality and diversified customer base
  • Industry-leading pipeline from Sponsor provides growth opportunity via ROFR

Most important for all dividend investors should be this: Digital Core REIT offers a total return of 10.01% comprising distribution yield of 4.75% for Forecast Year 2022 and DPU growth of 5.26% from Forecast Year to Projection Year 2023 based on the offering price. The REIT intends to distribute 100% of distributable income to unitholders in the first year and at least 90% thereafter. Distributions will be paid out on a semi-annual basis. Do note also that distributions will be declared in US dollars and unitholders will receive the equivalent amount in SG dollars (unless elected otherwise) so there could be some currency impact which would affect the eventual yield.

Investors who want in on of the fastest-growing commercial real estate sectors but “missed out” on Keppel DC REIT and Mapletree Industrial REIT, two S-REITs with data centre focused portfolios, may be keen to apply for this IPO. The 4.75% forecasted distribution yield is also relatively attractive compared to the Singapore 10-year bond yield which is only 1.71% at the time of writing.

I am rather optimistic about this IPO and would be keen to apply. After all, the list of cornerstone investors seem pretty extensive and if that’s where the big boys are going, perhaps I should follow too. I will be pondering my IPO application strategy over the next few days given that this IPO may be oversubscribed and I might not want to miss out! That being said, I already indirectly own shares in the Sponsor through my holding of OGIG ETF which was when I first came across Digital Realty so perhaps there is no need to FOMO now!

Disclaimer: Any ideas listed in this post are for information exchange only and not a recommendation to act. Please do your own due diligence.

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