Digital Core REIT added to FTSE EPRA Nareit Index. Is the worst over?

What happened?

Digital Core REIT was included in the FTSE EPRA Nareit Global Developed Index with effect from 15 September.

The index is an international REIT index designed to track the performance of listed property companies and REITs globally.

The CEO of Digital Core REIT’s manager, John Stewart, believes that the REIT should enjoy enhanced trading liquidity and attract new capital inflows from global index funds.

The news of the index inclusion provided a further boost to the share price of Digital Core REIT, which has recovered from a low of US$0.37 to reach US$0.59 on 14 September. 

Earlier in March, Digital Core REIT's share price fell sharply as the swift collapse of Silicon Valley Bank and the troubles swirling around First Republic Bank made investors increasingly jittery.

With Digital Core REIT’s exposure in the US and Canada, investors were naturally worried as to whether the REIT had parked any of its funds in these financial institutions.

A further worry was whether any of Digital Core REIT’s tenants had banking relationships with these fallen banks that could see a contagion effect that would cause a domino effect.

Digital Core REIT's CEO Stewart had to publicly assure investors that Digital Core REIT had no customer or banking relationship with the beleaguered banks and that three-quarters of annualised revenue was of investment grade or the equivalent.

Investor sentiment on Digital Core REIT has clearly improved over the past few months. Is the worst over for Digital Core REIT? Let us take a look at Digital Core REIT's recent operational performance and developments to find out. 

Is the worst over for Digital Core REIT?

#1 - Concerns about challenges faced by customer Cyxtera

In early June, Digital Core REIT announced that its second-largest tenant, later identified as Cyxtera Technologies Inc, has filed for Chapter 11 Bankruptcy.

Cyxtera represents 22.4% of Digital Core REIT's annualised rental revenue. Digital Core REIT estimated that in the event of a complete loss of revenue from Cyxtera, its DPU could plunge by US$0.02  or nearly 50% based on 2022’s DPU of US$0.0398.

While the news appeared to be negative for Digital Core REIT on the surface, the silver lining was that a Chapter 11 filing for Cyxtera meant that itcan now decide on which leases it wishes to accept or reject. This led to a jump 14% jump in the unit price of Digital Core REIT to in a matter of days.

The good news is that Cyxtera has not rejected any leases for Digital Core REIT so far. Based on Digital Core REIT’s assessment of the likelihood of lease rejection, management believes that its Los Angeles facilities stand the highest risk of rejection as market occupancy is sub-par at just 57%.

These two data centres bring in annualised rent of US$4.8 million which is around 4.5% of Digital Core REIT’s annualised total rental income using 2023’s first half (1H 2023) financial numbers.

Even if Digital Core REIT’s leases are rejected, the REIT may be able to backfill the vacant space at attractive rental rates as data centres remain in high demand.

Hence, it would seem like the worst-case scenario of a 50% plunge in DPU is unlikely to pan out.

Since then, it has been reported that Cyxtera's assets have drawn interest from multiple parties including Brookfield Corporation and Digital Core REIT’s sponsor Digital Realty Trust.

Another piece of good news is that Cyxtera has resumed paying its rent for July and that Digital Core REIT can claim June’s rent through the bankruptcy process.

#2 - Distributions impacted by higher finance expense

Digital Core REIT announced distributions per unit (DPU) of 1.92 US cents in the first half of 2023, a 7% decline from the first half of 2022.

Its gross revenue remained steady and the occupancy of its assets remained high at 97% as of June 2023.

However, Digital Core REIT’s finance expenses in the first half of 2023 came in at US$12.3 million, a five-fold increase from the US$2.4 million that was forecast for the same period.

Digital Core REIT’s cost of debt has also more than doubled from 2.1% back in the first quarter of 2022  to 4.7% for 1H 2023.

On a more positive note, Digital Core REIT has a relatively low gearing level of 34.2% as of June 2023, and 72% of its loans are now on fixed rates.

#3 - Management change announced

Digital Core REIT also recently announced leadership changes with David Lucey appointed as Chairman of the Board.

Serene Nah will join the Board as a non-independent director while Dave Craft will replace Daniel Tith as the REIT’s Chief Financial Officer.

These appointments take effect from 1 October, and could be aimed at bringing in fresh perspectives to help drive Digital Core REIT’s next growth phase.

After all, data storage requirements are expected to increase significantly with generative AI fuelling investments by semiconductor firms and microchip manufacturers. 

What would Beansprout do?

The inclusion of Digital Core REIT into the FTSE EPRA Nareit Global Developed Index has boosted sentiment towards Digital Core REIT once again. 

On the positive side, the data centre market could benefit from increased data storage demand with the AI boom. 

However, we would be looking out closely for whether the restructuring of its customer Cyxtera will be completed soon, and what this may mean for its leases with Digital Core REIT. 

We would also be watchful on how Digital Core REIT’s finance costs may increase further if interest rates were to continue rising. 

For now, analysts remain positive on the prospects of Digital Core REIT, with a consensus target price of US$0.68 as of 20 September 2023. 

This represents a potential upside of 28% compared to its price of US$0.53 as of 22 September 2023. 

Digital Core REIT is expected to offer a forward dividend yield of 7.0%, above the forward dividend yield of 4.7% offered by Keppel DC REIT and 4.4% offered by Mapletree Industrial Trust.

Check out our REIT comparison tool to compare data centre REITs and find the best REIT for your portfolio. 

Related links:

• Digital Core REIT share price and analysis

• Digital Core REIT dividend history