Digital Core REIT

[weijian]

Digital Core REIT IPO-ed slightly about 1 year ago in Dec2021 at 0.88usd (didn't know that Westerners will succumb to the recommendations of the local investment bankers to go onto the market with auspicious numbers).

It was a time when data center assets were raging hot, trading at >NAV (generally a rarity for REITs which uses fair value accounting) and interest rates were low.

Fast forward a year, besides the relentless rise in interest rates, some of the steam has been taken out of data center assets as Jim Chanos proposed that brick-and-mortar data centers' own big customers the cloud players, are going to be their biggest competitor.

REITs are generally asset-heavy, heavily financially engineered and pay out most of their earnings, leaving little cash on the BS. So it is interesting to see the REIT using precious cash to start a share buyback. It is also a rarity for REITs on SGX to buy back their own shares because the alternate and more lucrative use for cash would be to make acquisitions that would increase the Manager's AUM (and fees).

To date, close to ~5million units (0.44% of units) has been purchased at cost of ~3mil USD since the start of Dec2022.

Share buyback on 14th Dec 2022:
https://links.sgx.com/1.0.0/corporate-an...b8bf39e6a9

It does seem that the discount to NAV (~30% from 1H22 started NAV of 0.87usd) is impeding its ability to make accretive acquisitions, and the Manager thinks that a sharebuyback might just do the trick!

IPO in Dec2021 and 19.4x oversubscribed:
https://www.straitstimes.com/business/co...subscribed

[ghchua]

Hi weijian,

Share buybacks, when done at appropriate levels, does benefit a REIT in the long run. I remembered Saizen REIT was very aggressive buying back units from the market last time and more recently, Keppel REIT also did some decent buybacks.

As to your concerns cloud players building their own data centers, I think it is not a case of more insourcing, but rather part of their strategy to build economics of scale. But outside their own home country, these players would still prefer to outsource rather than doing it themselves as there is no scale to reap the benefits. So, outsourcing is here to stay, due to limited capital for these players for physical assets.

Yes. Digital Core REIT do have a problem due to its unit price. Which is why they scaled down their recent acquisition.

[weijian]

hi ghchua,

Thanks for the additional information. I do remember long time ago, as a shareholder of once-upon-a-time Macquarie International Infrastructure Fund (MIIF), MIIF also did aggressive share buybacks using the substantial cash on their balance sheet after selling off their assets. The buybacks were done at "decent to attractive" discounts to NAV but did nothing much to increase the share price. I remember during the AGM, some shareholders were complaining that cash was "wasted" on share buybacks as it didn't materially push up the share price. Eventually when MIIF liquidated itself, it came in useful because the liquidated proceeds were shared with less people. I believe the same can probably be said of Saizen REIT.

Digital Core REIT is a newly listed REIT and I believe the sponsor wants to continue to earn the Mgt fees and sell its assets to the REIT. As such, it is interesting to continue to observe and see how all these actions eventually translate to future performance. Will such buybacks push up the share price and sufficiently narrow the gap to NAV? Will these share buybacks help to offset the issued units (mgt fees) at deep discount to NAV?

As for debate on insourcing/outsourcing, to be honest, I have no idea which is a stronger force since I am not an insider. Both sides of the divide have their arguments. But from how the market has reacted, we can conclude that the halo effects of data center assets have been lessen to a great extent. After all, market efficiencies are a result of the gap between expectations and reality.

Finally, while it make sense as a value investor to buy at deep discounts to NAV. But it may not be applicable for REITs. REITs that are selling at huge discounts to NAV, are actually "stuck" and are not able to effectively use equity issuance to buy assets that are DPS/EPS accretive. OTOH, REITs selling at >NAV are able to issue new (expensive) equity to buy accretive assets, making them even more attractive to investors and hence increasing their share price even more. This creates a virtuous cycle. The former is stuck in the mud. As such, it is probably more attractive for REIT investors to buy "slightly expensive" than "dirt cheap".

[ghchua]

Hi weijian,

MIIF is actually not a REIT but I understand where you are coming from in your analogy.

I think there are few issues with data centre REITs presently and that is not Digital Core REIT only. First, it is higher interest costs. Second, inflation. I think the second is more of an issue because DC REITs normally locked in longer tenure leases and they can't just increase rental immediately to offset the higher interest rate and higher costs, as compared to say, hospitality REITs which can increase room rate and retail REITs which can increase rentals.

As to your point of value buys for REITs, I think it depends on each individual REIT. I won't rule out REITs trading at decent discount from NAV. There are ways that a REIT manager can deliver value besides just using equity to buy assets. For example, they can do AEIs to increase the value of their assets and deliver higher DPU organically and also try to increase occupancy of their assets. An example is Sabana REIT, which had traded at a decent discount from NAV previously. Recently, the discount had narrowed. If all else failed, the manager can also decide to liquidate the REIT and unitholders can get back near NAV value of their investment in the REIT, thereby unlocking value.

[weijian]

Many interesting points bought up by Dr Mak but I thought the structure is the most important part here.

DIGITAL CORE REIT: ANOTHER FOREIGN REIT ON A BUMPY RIDE

We pointed out a number of unique features and concerns about DCREIT. First, its sponsor and manager, Digital Realty Trust, is listed on NYSE and was the sixth largest publicly traded US REIT. It is the first time that a SGX-listed REIT has a sponsor and manager which is another (listed) REIT.

The sponsor carved out 10 freehold data centres in US and Canada out of a global portfolio of 290 facilities in 26 countries to form the initial portfolio for the listing of DCREIT. We questioned how the 10 data centres were selected and valued.

We concluded our writeup with this statement: “Digital Core REIT has a financially strong sponsor listed on the largest stock exchange in the world. However, the sponsor has its own unitholders to account to, and the interests of those unitholders may not necessarily be the same as the unitholders of Digital Core REIT here.”

https://governanceforstakeholders.com/20...umpy-ride/

[weijian]

BT headlines doesn't look good - 50% cut in DPS. Its 2nd biggest customer Cyxtera filed for bankruptcy on 4/6 and the REIT Manager has responded on 5/6. Pretty fast response.

Digital Core REIT Addresses Customer Bankruptcy

Digital Core REIT (SGX: DCRU), a leading pure-play data centre REIT listed in Singapore and sponsored by Digital Realty, announced today that its second-largest customer, a global colocation and interconnection provider representing approximately $16.3 million, or 22.4% of Digital Core REIT’s annualised rental revenue, filed for chapter 11 bankruptcy protection in the United States Bankruptcy Court for the District of New Jersey on 4 June 2023.

All else equal, if 100% of the annual revenue from this customer were to be eliminated, the Manager estimates that Digital Core REIT’s distribution per unit, or DPU, would be reduced by approximately 2.00 U.S. cents; total asset value would be reduced by approximately $85 million, or roughly 6%; net asset value, or NAV, per unit would be reduced from $0.81 to $0.74, or approximately 9%; and aggregate leverage would increase by approximately 200 basis points, from 34.4% to 36.5%.

https://links.sgx.com/FileOpen/Digital%2...eID=761531

[weijian]

When a shareholder's question contains parts related to other companies, my general observation is that Mgt will decline to comment on those parts and just focus on answering the part relevant to the company. So it is a surprise that DC REIT Mgt actually publicly talked about other SGX listed data center REITs. Maybe angmohs are not as modest as Asians and don't care?

Some other interesting snippets from the MoM - (a) all SBB shares are cancelled, (b) the growth of the REIT is currently capped by its large discount to NAV, © Chairman agrees strongly that NEDs should be partly paid in shares.

On hindsight, maybe the Sponsor should have done a better selection of assets at IPO? By now, they should have seen that conditions on the SGX are much conducive to continue to rear a golden goose for its eggs than slay it for the meat.

SUMMARY OF QUESTION-AND-ANSWER SESSION AT THE ANNUAL GENERAL MEETING HELD ON 15 APRIL 2026

Question: There are three data centre REITs in Singapore. Could you please elaborate on strategies moving forward compared to the other three REITs?

Answer: Keppel DC REIT trades at a premium partly because of their presence in Singapore, which we aspire to emulate over time. Singapore, along with Northern Virginia and Frankfurt, is one of the best and most competitive data centre markets globally. While we are focused on expanding our exposure in this region, we have excellent growth prospects across the rest of our portfolio as well.

Similar to the dynamics in Singapore, demand in Northern Virginia and Frankfurt is growing rapidly – not just from AI, which is the marginal buyer, but also from a strong underlying demand base and limited new supply, leading to robust rent growth that is reflected in our results.

https://links.sgx.com/FileOpen/Digital%2...eID=888608

P.S. I categorically state that I am not insuisating that the Sponsor has done anything wrong in the IPO process. 

[weijian]

Approaching its 5th full year as a public REIT, DCR has done a major revamp of its portfolio - selling relatively old US data centers (incepted at IPO) and using part of the proceeds to buy newer data centers in Spore/Osaka and share buy backs (SBB). However the majority of the proceeds (~60%) will be used to retire debt instead and I suppose this contributes a large portion to the DPU accretive-ness of this whole transaction package.

I thought it will be interesting to do a check on the original acquisition price vs the current sale price to see whether DCR has done a "Manulife US REIT" on OPMIs.

3 US data centers purchased during Dec2021 IPO:
- 90% interest in 371 Gough in Toronto for US$183 million (100% implied valuation US$203 mm)
- 90% interest in 200 N. Nash in Los Angeles for US$64 million (100% implied valuation US$71 mm)
- 90% interest in 8217 Linton Hall in Northern Virginia for US$235 million (100% implied valuation US$261 mm)

3 US data centers to be sold in Aug2026:
- 90% interest in 371 Gough in Toronto for US$127 million (100% implied valuation US$141 mm)
- 90% interest in 200 N. Nash in Los Angeles for US$79 million (100% implied valuation US$87 mm)
- 39% interest in 8217 Linton Hall in Northern Virginia for US$110 million (100% implied valuation US$283 mm)

100% valuation of the 3 US data center during Dec2021 IPO = 203+71+261 = 535mil
100% valuation of the 3 US data center when sold in Aug2026 = 141+87+283 = 511mil (~-5% from IPO valuation)

2 out of the 3 assets had fair valuation increased with the smallest asset (200 N. Nash) making the biggest % gain at ~20% and biggest asset (8217 Linton Hall) having a high mid single digit % gain. However, the middle sized 3rd asset had a whopping 30% reduction in fair value, largely due to a customer (one occupied ~30% of the space) going bankrupt and vacating at end 2022. So there you have it - 1 big lemon added into the orange juice mix.

Digital Core REIT Reaches Agreement to Establish Presence in Singapore, Expand in Japan, Sell Interests in Three Assets in North America

Digital Core REIT (SGX: DCRU), a leading pure-play data centre REIT listed in Singapore and sponsored by Digital Realty (NYSE: DLR), announced today it has reached an agreement to sell interests in three North American assets and redeploy the proceeds to acquire partial interests in one data centre in Singapore, one data centre in Osaka, pay down debt, and repurchase units on the open market.

The transaction is expected to be approximately 4.1% accretive to Digital Core REIT’s Distribution Per Unit, or DPU, and aggregate leverage is expected to improve by approximately 290 basis points, from 39.2% as at 30 June 2026 to 36.3% pro forma for the contemplated transaction. The proposed transaction includes the sale of Digital Core REIT’s 90% interest in 371 Gough in Toronto to Digital Realty for C$180 million, or US$127 million; the sale of its 90% interest in 200 N. Nash in Los Angeles to Digital Realty for US$79 million; and the sale of a 39% interest in 8217 Linton Hall in Northern
Virginia to Digital Realty for US$110 million.

In addition, Digital Core REIT has agreed to acquire a 2.5% interest in 11 Loyang Close in Singapore from Digital Realty for S$87 million, or US$68 million. Finally, Digital Core REIT has agreed to acquire an additional 25% interest in Digital Osaka 3 from Digital Realty for ¥17.6 billion, or US$108 million, increasing its ownership stake from 20% to 45%.

https://links.sgx.com/1.0.0/corporate-an...a8ec9662dc

[specuvestor]

Nice work Weijian you spot the lemon

[weijian]

DCR had its 2nd largest tenant defaulting in mid 2023. The 2nd largest tenant occupied a total of 6 facilities (5 of them 100% and the 6th at 4%). So it would be interesting to take a look at how those 6 facilities fared (thus far):

Tenant occupied 100% of the first 5 assets but just 4% in the 6th asset
1. 90% of 1500 Space Park Drive for US$101.7 million (IPO) --> end FY25 valued at 90.9mil
2. 90% of 2401 Walsh Avenue for US$100.8 million (IPO) --> divested at similar prices in Nov2023
3. 90% of 2403 Walsh Avenue for US$62.3 million (IPO) --> divested at similar prices in Nov2023
4. 90% of 200 North Nash Street for US$64 million (IPO) --> end FY25 valued at 58.5mil
5. 90% of 3015 Winona Avenue for US$52 million (IPO) --> end FY25 valued at 48.6mil
6. 65% of Wilhelm-Fay-Straße 15 and 24 for US$350 million (IPO+additional stakes) --> end FY25 valued at 465.7mil

So this 6 assets on aggregate didn't fare too badly - (1) 2 of them were divested within 6 months at similar prices to IPO, (2) 3 of the assets have experienced ~10-15% drop in fair value over the last 5 years but the cumulative losses of this 3 assets are more than made up by the biggest asset's gains.

And if we look at all remaining assets on DCR, the only obvious lemon has just been sold with the others relatively ok (I would think that ~10-15% reduction in fair value is probably expected with higher rates).