UOB Kay Hian analyst Jonathan Koh has kept his “buy” call on Digital Core REIT with a higher target price of 99 US cents ($1.36) from 95 US cents previously
Koh’s report dated Jan 8 comes after units in the REIT declined following news that one of its tenants will not be renewing its lease for 8217 Linton Hall in Northern Virginia. The news was announced on Jan 2.
The analyst is not too worried over the temporary vacancy, saying he expects a downtime of six months and a new tenant to start contributing in 1Q2026 given the strong demand and low vacancy rate of below 1% in Northern Virginia.
However, he feels investors have “overlooked” the positive developments announced in November and December 2024, adding that the news was “not fully appreciated”.
On Dec 6, 2024, the REIT announced that it completed the acquisition of an additional 15.1% interest in the fully fitted freehold Frankfurt data centre from its sponsor, Digital Realty, for EUR71 million (US$75.1 million or $102.8 million). The stake, which brings the REIT’s total interest in the data centre to 65% from 49.9%, is accretive to its FY2023 distribution per unit (DPU) by 3.1% on a pro forma basis, Koh says.
“The Frankfurt data centre generated net property income (NPI) of EUR13.4 million or US$14.7 million in 1HFY2024. The additional stake provides an attractive NPI yield of 5.7%,” the analyst points out.
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The purchase consideration represents a discount of 17.8% to the latest valuation of US$628.7 million and is funded by a Euro-denominated term loan at an all-in cost of 3.6%.
Geographically, data centres in Germany and Japan have expanded by 5 percentage points to 39% of annualised rent, with Frankfurt making up 32% and Osaka at 7%. With the acquisition, Digital Core REIT has reduced its reliance on its North American portfolio by reducing it to 61% from 66%.
The Frankfurt data centre has an occupancy rate of 98.5% in 2QFY2024, marking a 6.3 percentage point increase q-o-q after the REIT manager signed several new leases. Two of the anchor tenants at the data centre, hyperscale cloud service providers rated AAA and AA+ respectively, also renewed their leases for five years at positive cash rental reversion of 2.0% in 1QFY2024, Koh notes.
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He adds that there is potential for growth to lease the remaining 1.5% space in this data centre.
Following the acquisition, the REIT’s net asset value (NAV) per unit would increase by 4.3% to 72 US cents while its aggregate leverage would increase by 2.1 percentage points to 36.6%.
On Nov 11, 2024, the REIT said it had reached a three-year agreement with a next-generation artificial intelligence (AI) computing developer to occupy the entire remaining capacity within its Toronto facility. The lease will commence in the first quarter of 2025.
“The new tenant accounted for 33% of capacity for [Digital Core REIT’s] Toronto data centre, restoring occupancy from 66% to 100%,” Koh notes. “The new tenant is expected to generate [an] annualised rent of US$4.2 million, which increases [the] annualised rent for [the] Toronto data centre by 45%.”
To this end, the analyst expects the REIT’s Toronto data centre to account for 13% of its annualised rent in 1Q2025, where it was contributing 10.6% in the 3Q2024.
In addition, Digital Core REIT signed direct colocation leases with 60 end-user customers and leased out 60% of the capacity of the two Los Angeles data centres, which it took over on Oct 1, 2024.
“These leases generated an annualised rent of US$7 million, which is 30% above the previous in-place rent (management previously guided for a 50% reduction of in-place rent),” says Koh. “We expect the two Los Angeles data centres to be 80% leased and annualised rent to be 70% higher y-o-y by year-end given continued healthy demand and leasing momentum.”
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Looking ahead, the analyst sees the growing demand for AI as a positive for the REIT, citing Microsoft’s investment goal of US$80 billion in FY2025 and US$20 billion in the 1QFY2025 to build AI-enabled data centres to train AI models and deploy AI and cloud-based applications around the world.
“More than half of this total investment will be in the US, reflecting Microsoft’s commitment and confidence in the US economy. Microsoft’s AI business in on track to exceed annual revenue run rate of US$10 billion in 2QFY2025, the fastest business unit to reach this milestone in its history,” Koh notes. “Copilot is seeing strong adoption and its Azure AI has generated demand for a broad range of cloud services, such as data and analytics.”
Despite the higher target price, Koh has lowered his FY2025 DPU forecast by 7% due to the downtime at Linton Hall Road. He has, however, increased his FY2026 DPU forecast by 3% due to the acquisition of the additional 15.1% stake in Frankfurt data centre, successful backfilling of Toronto data centre and the securing of a replacement tenant for data centre at Linton Hall Road.
Based on his estimates, Digital Core REIT provides a distribution yield of 6.8% for FY2025, the highest compared to its data centre peers, Keppel DC REIT and Mapletree Industrial Trust (MINT) with yields of 4.7% and 6.2% respectively. Digital Realty and Equinix’s yields are at 2.7% and 1.8% respectively.
Units in Digital Core REIT closed 2.5 US cents higher or 4.46% up at 58.5 US cents on Jan 9.
