8 Things You Might Not Know About Digital Core REIT (SGX:DCRU)

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The funny thing is that; data centers have been around since the 2000s. Yet only in recent years did they really take off in popularity.

The most recent iteration of this regard can be seen in the recent IPO of Digital Core REIT, a 100% freehold data center REIT sponsored by Digital Realty. While initially offered at a NAV of US$0.88 cents, the counter has recently reached a high of US$1.16.

For those who scooped up shares during IPO, they would have received a 30% gain right off the bat. Not bad for a REIT supposedly focused on income generation.

Digital Realty is a industry leader in the data center space, and is the largest owner and operator of data centers globally. They have extensive experience in operating and administering these assets, and also manage their own flagship REIT on the NYSE.

Very impressive.

Digital Realty Trust has been able to grow it’s asset count exponentially, from just 23 properties in 2004, to the 291 centers it owns today. With such an amazing track record, we’re sure investors are in good hands.

Being the inquisitive readers that we are, we decided to probe deeper into the prospectus to understand more about this REIT. Knowledge is power after all, and we’ll like to know more about it’s prospects before investing too.

1. The Mandate

The REIT expects to invest in a diversified portfolio of stabilized income-producing real estate assets located globally. These assets are required to meet certain criteria;

  • Achieves a minimum occupancy of at least 90%.
  • Achieves an average rental rate at least comparable to the market rental rate for data center assets.
  • The Manager must be satisfied that there are no building upgrades and enhancements required within two years of the Proposed acquisition.
  • Is suitable for acquisition by Digital Core REIT, taking into account market conditions at the time.

The term “Fully developed” comes to mind. These are all pretty stringent requirements, and should be able to safeguard the REIT against more unpalatable assets.

2. Concentrated Customer Base

Concentration risk seems to be present here as the top 6 customers make up 99.9% of Base rental income. Alarmingly, the largest customer contributes 35.9% of income.

While data center assets clearly have high demand, and low customer churn rates, this factor should be something readers should be aware of.

3. Hyper-scale Segment Focus

68.5% of the IPO portfolio is leased to Hyper-scale customers. These are mostly major cloud providers such as Amazon, Google, and Microsoft, who continue to grow and need the supporting critical infrastructure. The remainder is leased to Co-location and Enterprise operators.

For more information on data centers and the relevant nomenclature, do check out our research piece here.

4. Minimal Customer Churn

The prospectus emphasizes the track record of the IPO portfolio, which has a average historical occupancy rate since 2012 of 99.4%. Partly because one-third of the IPO Portfolio is comprised of “Shell” data centers.

A standard arrangement for these centers require the customer to invest capital to build out the mechanical and electrical infrastructure of the data center which they have rented from the REIT.

This initiative increases the tenant’s upfront costs, and sets the stage for future customer retention and stickiness.

5. Expiring Leases

Leases expiring in 2022 and 2023 represent only 0.1% and 0.1%, respectively, of Base Rental Income for the month of June 2021. This is great as investors can look forward to stable, recurring cash flows. Below you can view the timeline of lease validities taken from the prospectus.

Hopefully the REIT can proactively and successfully find replacement tenants for the subsequent years. Something which investors should continue to monitor going forward.

6. Lock-up Period 1 & 2

There’s a lock-up period for the shares held by the Sponsor and Manager. Among the cornerstone investors, DBS bank has also agreed to a lockup arrangement for the first lockup period only.

Do take note that the bank’s lockup units only apply to those held by the bank itself, and not those held by retail investors and the bank’s wealth investors.

The first lockup arrangement lasts for a period of 6 months after the IPO, during which no shares held by the Sponsor, manager, and DBS bank are allowed to be pledged, transferred, or sold.

A similar arrangement will be effected for the next 6 months immediately after the first lockup period. The difference being that now it only applies to 50% of the shares held by the Sponsor alone.

7. Net Property Income Contributions

Below is a table of the income contributions for the respective properties. Those highlighted in gold contribute more than 10% of overall net property income.

They have a mix of long and medium lease properties with varying WALEs. Unsurprisingly, those with longer WALEs contribute lower amounts to the overall property income.

This is in line with longer tenures which comes with more favorable rates. Many of the properties are on the older side as well, which brings us to our final point.

8. Negative Fair Value Changes In Property Value

We noticed that the IPO portfolio’s Net property income growth had been relatively muted these past 3 years. Something we should be concerned about if we do invest in the REIT.

As seen on Pg 134 of the Prospectus.

Another objectionable point is that as a whole, the IPO properties have been on the receiving end of negative fair value changes in property value.

On Pg 134.

Honestly speaking, property valuations are a result of a multitude of factors, some of which do not really affect the intrinsic value of the property. Furthermore, these amounts make up less than 5% of the total portfolio value. We wouldn’t be too worried about it. For now.

But it is something we should be aware of moving forward.

And Here We Are

In the current low-yield environment, we could definitely use a extra REIT counter to boost our income. And it comes with a complete data center portfolio as well.

Both Digital Core REIT and Daiwa House Logistics Trust also help to provide some much-needed diversity to our local bourse.

Not a fan of using Institutional Investors as votes of confidence, but if you do, then it’s great to know that there’s a long list of them applying for this REIT’s IPO.

As usual, do your due diligence, and make sure this investment is suitable for you before you invest.

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