The market was just delighted with this Singapore REIT – Digital Core REIT.
Last week, its shares jumped 12% in one day… Wow.
Market chatter was because DBS released a positive report that many companies are seeking to buy out Digital Core REIT’s recently defaulted tenant – Cyxtera.
Seems like good news, right?
At current prices of US$0.50, Digital Core REIT shares trade at 8.6% dividend yield. And still trading at a bargain 40% discount to its book value.
Looking at things from afar, It’s remarkable how could easily flip on its head about share prices.
Disclaimer — I personally own a position in Digital Core REIT.
Is it time to buy this Singapore REIT?
Well, let’s dive in.
Why do Digital Core REIT shares keep dropping?
Digital Core REIT is a “pure-play” data-centre REIT (what you need to know about the Singapore REIT).
All these while, the big problem with Digital Core REIT’s lousy shares performance has been nothing but a bummer.
That’s because since listing, its shares were caught up with plain, bad timing.
First, Digital Core REIT got listed just before the Fed decided to ramp up interest rates. Then, earlier this year the market reacted violently to Digital Core REIT’s second largest tenant – Cyxtera – blowing up.
I mean, the market obviously didn’t like the word “default”. It obviously didn’t like Cyxtera contributing 22% of Digital Core REIT’s rental income.
By the way, Cyxtera is also a tenant to Mapletree Industrial Trust and Keppel DC REIT.
The market is emotional in its own ways — from gloom and doom, to hopes and expectations. In March 2023, Digital Core REIT shares plunged to US$0.40 before recovering… then fell back to US$0.41 again before soaring 40% from its 52-week low.
What I’m concerned about this Singapore REIT?
Recall the Singapore data centre REIT article I wrote about on Jim Chanos’s latest short position —
Well, a big problem why markets are usually sensitive with Singapore data centre REIT shares is because of data centre REIT’s “opaqueness”.
The thing is, the market just doesn’t like that these data centre REITs don’t disclose their tenants. I’m not exactly sure why.
What I’m sure is it can be frustrating not to know whether these tenants are financially sound — until one of them goes bust.
And that’s why I don’t really like about Digital Core REIT.
Here’s another thing many people are probably more worried about. So far, I don’t have an idea whether Cyxtera would eventually be bought out by other companies.
If the worst case really plays out…
Cyxtera goes bust, Digital Core REIT can’t find new tenants, then like what management said — Digital Core REIT’s DPU could be halved. Digital Core REIT is screwed. Unitholders are screwed.
But I don’t believe that for one bit.
Why? Here’s my personal views…
Now, I don’t have a strong view of how long interest rates will last.
I also can’t tell whether Cyxtera will really be saved by other investors.
And I might sound optimistic here.
But hear me out first…
I don’t think Cyxtera’s default would really impact Digital Core REIT.
This is because Cyxtera is a “co-location” provider. A co-location provider rents out space to other sub-tenants. In other words, even if Cyxtera goes bust, Digital Core REIT can simply take over Cyxtera’s sub-tenants.
Currently, Cyxtera leased three properties from Digital Core REIT — with one property having a medium risk of sub-tenant vacating (see red boxes in DBS report below).
Now, that’s half the story told.
If these sub-tenants really decide to pull out, Digital Core REIT can always rent out these spaces again. Many of Digital Core REIT’s assets are rented at “below-market” rate, which gives the data centre landlord huge potential to raise rent in the future.
In fact, this is what management has to say about their rent to Cyxtera: “The customer’s in-place or passing rents are below market in each of the metros where the customer leases capacity from Digital Core REIT. Current market conditions are tight, with vacancy rates in the low- to mid-single-digits across all three metros…”
Many of these data centres are located in technology-heavy regions, like Silicon Valley, where there’s still strong demand for data storage, and a limited supply of data centres.
Of course, in a base case scenario, my gut feel is Cyxtera will eventually be bought out by other investors, saving Digital Core REIT the trouble of bringing new subtenants.
How to play Digital Core REIT?
What has always stood out for me is Digital Core REIT’s sound fundamentals.
I don’t disagree Digital Core REIT has pretty good US data centres. In fact, Digital Core REIT’s 11 properties are almost fully occupied. This shows its asset quality. And also means the REIT has been consistently collecting a healthy stream of rental income.
What’s more, it has a strong sponsor, Digital Realty, which is the third largest data centre operator in the world. This gives it some sort of unfair advantage compared to other data centre operators — that don’t have a “data centre heritage”.
One more thing…
Unlike weaker Singapore REITs that invest overseas, Digital Core REIT’s financial profile is still healthy. Most of its debt will only be refinanced by 2026 – total US$550 million.
And most of its interest payments are fixed. This gives it plenty of room for margins of error – for instance, interests going up.
Even after Digital Core REIT recently bought its Frankfurt data centre, its gearing only jumped to 34%, which gives it plenty of firepower to continue buying more assets.
So far, it seems like Cyxtera is a one-off problem. It’s the only “high-risk” tenant in Digital Core REIT’s top customer list and has already defaulted. Which means, market has priced in the “worst case” scenario.
Other tenants — including the lousy ones (see red below) only make up about 1% of total rental income.
By the way, DrWealth has a great table on credit quality/ratings.
Even if these low quality tenants defaulted, I believe Digital Core REIT can easily lock in new tenants – at higher rent – in the future.
Digital Core REIT vs Keppel DC REIT – which to buy?
I’ll be brutally honest here… I think both are great plays for data centres. But if you want a much bigger “bang for your buck” dividend yield plus capital upside, and don’t mind taking on US dollar currency risk, I’d go for Digital Core REIT.
It’s a much bigger bargain than Keppel DC REIT today.
Last year, Keppel DC REIT paid 4.5% yield versus Digital Core REIT at 8.6% yield.
And if you’re worried about share price tumbling, think about this: if data centres are in trouble, even Keppel DC REIT won’t be spared.
My final thoughts
Data centres are probably riding one of the biggest tailwind today. And data centres aren’t just about data storage. Where you store these data is important – and good property investors will tell you it’s about “location”.
Digital Core REIT owns data centres located in popular areas where there’s a huge demand for data storage. Generally, data centres have high switching costs. So it doesn’t make economic sense to keep moving to find cheaper data centres
That means, once a data centre locks in a tenant, it’s hard for tenants to leave.
Put it this way, it’s not that easy to tear down computers, servers and equipment, then move to another data centre. What’s more, you need time to customize and re-install your infrastructure again.
Everything we need to do online nowadays creates and consumes more data. These data need a physical place to be stored and managed – servers, computers and equipment to analyze.
Many big tech companies need to grow their data centre storage.
If you’re a long term stock investor, ignoring short-term price actions, and believe in the future of internet, I think Digital Core REIT (also in my 10 Best Singapore REITs to Buy) is probably a pretty good buy.
Sometimes, investing can be simple.
Willie Keng, CFA
Founder, Dividend Titan
Dear Willie,
I’m in sync with you on this.
I’ve scooped up my fair share of this baby during the recent turmoil. Without which, how to collect at such prices?
Like Uncle Warren says, be greedy when others are fearful….
Have a nice day