summation
- If you want to invest in REITs but are lacking in growth, try investing in data center REITs.
- If you look at the performance so far, it has performed better than Reality Income in both stock price and dividends.
- The cost of financing is expected to rise due to higher interest rates. About 50% of total debt is scheduled to mature within five years.
- The key to future performance is whether the demand for data centers, which continues to maintain a high level, can be covered.
index
- [Higher interest rates, upcoming debt repayments]
- conclusion
introduction
Company Introduction
Data center REITs are literally companies that entrust and manage server computers, lines, etc. Nowadays, cloud computing, media streaming, and big data have become commonplace, and servers have gone far beyond having a few computers in one corner of the office. Not only must a significant amount of space be allocated, but 24-hour stable power supply and temperature management must also be provided. A company that creates a comfortable space for computers and provides consignment management is a data center, and today's topic, Digital Realty, is a data center REITs company that operates 300 data centers in 24 countries and has over 5,000 corporate customers.
Profit Structure
50% of Digital Realty's revenue comes from the United States, with a diversified portfolio in that order: 24% from Europe, 7% from the UK, 6% from Singapore, and 13% from other countries. In addition to directly holding portfolios, data centers are also held through equity investment in the form of joint ventures (JVs). The Chicago-based JV owns a 35% stake and has annual revenues of $740 million with a 6.5% return on capital. Another joint venture, Nova JV, has annual revenues of about $1.3 billion with a 20% stake and 6% return on capital.
Investment Point
Dividends and growth potential
If you think of data center REITs as companies that have recently started their business and have grown rapidly, or that will appear and then disappear like many IT-themed stocks, you are mistaken. Although the recent decline is painful, it showed excellent growth potential, enough to consistently outperform the Nasdaq during the period.
Digital Realty vs Nasdaq Stock Price 2004-2023 (Data Source: Yahoo Finance)
You may say that comparing individual stocks and Nasdaq is too biased, but it is not easy to catch up even if it is similar to Nasdaq during the relevant period. Below are the stock price charts of Realty Income and Nasdaq, the most popular REIT stocks that are familiar to even Koreans.
Realty Income vs Nasdaq Stock Price 2004-2023 (Data Source: Yahoo Finance)
Not only the stock price but also the dividends are solid. This is not a comparison article with Realty Income, but if you compare Realty Income, a representative REIT and Dividend Aristocrat stock, with dividends, you can see that Digital Realty has also shown a steady rise. Rather, the CAGR for that period was 11.76% for Digital Realty and 4.87% for Realty Income, leading Digital Realty. (For comparison, Realty Income dividend, which is a monthly dividend, is converted to quarterly basis)
Digital Realty (DRL), Realty Income (O) quarterly dividend amount 2004-2022 (Data source: Yahoo) Finance)
Of course, when making an investment decision, the special characteristics of the data center industry must be taken into consideration, and the stable portfolio of realty income that has been shown for a long time and the reliability of the dividend that has been firmly maintained cannot be ignored. However, if you simply look at the stock price and dividends, choosing Digital Realty can be seen as a much better choice.
Risk
Interest rate increase and REITs
As with all stocks, there are not only advantages. REIT stocks, including Digital Realty, must pay attention to interest rates as they deal with real estate. This is because leverage through rental income and loans is the basic profit structure of REITs. This is why NASDAQ has succeeded in rebounding since September 2022, when inflation peaked, but REITs are still unable to recover.
REITs ETF (VNQ) vs NASDAQ ETF (QQQ) (Source: Yahoo Finance)
FED base interest rate trend (Source: Investing.com)
US Consumer Price Index (CPI) (Source: Investing.com)
In the case of NASDAQ, after the CPI peaked and confirmed a decline, it reached a low point and began a rebound, while REITs are still unable to move beyond the lowest point. In the case of technology stocks such as Nasdaq, the economic and industry conditions are more important than the interest rate itself, while in the case of REITs, the economy is also important, but the interest rate itself is directly related to profitability. However, in the case of Digital Realty's stock price, it appears that it has already begun to rebound, starting with Open AI's Chat GPT issue and the impact of the strong business conditions in the data center sector, which was confirmed by NVidia's earnings surprise.
Higher interest rates, upcoming debt repayments
However, the interest rate hike issue is still alive. Although Digital Realty is slightly out of the decline of REIT stocks, interest rates that show no signs of lowering are still a risk. This is because loans borrowed during a period of low interest rates must be converted to the current higher interest rates. Digital Realty in particular has a significant amount of debt coming due in 2025-26. Therefore, there is a high probability that Digital Realty's stock price will be rerated depending on the interest rate level (or forecast) at the relevant time.
conclusion
Digital Realty is judged to be a good investment that can capture the advantages of REITs and the growth potential of a data center at the same time. The current slump of REIT stocks is 1. Interest rate increase, 2. This is largely due to the difficulty in raising rents due to the economic recession. Therefore, Digital Realty can be said to be in relatively better conditions with respect to at least issue #2** based on high data center demand.
Of course, this does not mean that now is the right time to invest, just because the conditions are better. The worsening of profitability due to interest rates is as uncertain as the overall stock price level. If you are confident in predicting interest rates, if you want to ride the recent explosion of AI revolution, etc., but want a slightly safer choice, if you want to have a small portion of REITs from now on, Digital Realty may be a good choice.
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