UOB Kay Hian’s Jonathan Koh has maintained his “buy” call on both Mapletree Industrial Trust (MINT) and Digital Core REIT (DCR), with target prices of $3.36 and 98 US cents ($1.37) respectively.
This is in contrast to the position of US hedge fund manager Jim Chanos, who was reported by the Financial Times on June 29 to be raising hundreds of millions for a new fund that takes short positions on REITs listed in the US.
Chanos’ reasoning was that cloud service providers such as Amazon Web Services, Google Cloud Platform and Microsoft Azure, prefer to build their own hyperscale data centres based on their own design, rather than lease space from data centres.
Chanos thinks that the three cloud service providers above, which are Digital Realty, Equinix and Iron Mountain’s largest customers, will then become their biggest competitors.
However, Koh points out that the share prices of Digital Realty, Equinix and Iron Mountain were relatively unchanged on June 29 and 30, although trading volume was exceptionally high during these two days.
“Investors in the US did not fall prey to Chanos’ marketing ploy to raise funds for his new fund,” Koh says.
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Koh instead thinks that cloud service providers are a source of growth, adding that many companies are shutting down their standalone data centres, which are costly and inefficient to operate, and switching to cloud service providers instead.
Specifically, cloud service providers and social media companies are key drivers of demand for colocation data centre capacity, with Koh saying that they are likely to sign leases for purpose-built hyperscale data centres of more than 100 megawatts (MW) on a single-tenant basis.
Furthermore, cloud service providers adopt an asset-light business model by leveraging on outsourced data centres provided by Digital Realty, Equinix and Iron Mountain so as to generate higher ROE.
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They also sign long-term leases with their data centre landlords to ensure their outsourced data centre capacity is locked in.
Koh highlighted that companies are adopting a multi-cloud strategy by tapping several public and private clouds provided by cloud service providers for different workloads, sometimes in addition to their in-house data centres.
Several software companies, such as Snowflake, have developed new tools to manage applications across various public and private clouds, which facilitate the migration to a multi-cloud strategy, and companies prefer to use multiple cloud service providers to avoid being locked into one external vendor.
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With the fundamentals for data centres remaining positive, Koh has zoomed in on Digital Core REIT (DCR) and Mapletree Industrial Trust (MINT) as his “buy” picks within the sector.
For DCR, Koh says that its portfolio remains resilient, and the occupancy rate for all 10 of its data centres remains at 100%.
DCR has a long WALE of 5.5 years and all its leases contain cash rental escalation of 1-3%.
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Its holdings are also insulated from electricity price variations, as all lease contracts are structured with energy costs 100% reimbursed by customers.
63% of DCR’s leases by net rentable sq ft (NRSF) are on a triple net structure, whereby real estate taxes and property expenses are absorbed by tenants.
However, Koh expects its cost of debt to increase from the current 2.1% to 3.6% in 2023, assuming the US Fed Funds rate hits 3.25% by end-2022. DCR has maintained the proportion of borrowings hedged to fixed rates at 50%, and aggregate leverage remains low at 26%.
For MINT, Koh says the REIT is committed to its goal of allocating two-thirds of assets under management (AUM) to data centres, Data centres have expanded by 12.9 percentage points to account for 54.1% of AUM in FY2022 ended March.
MINT also will benefit from a full-year contribution from its acquisition of 29 US data centres in FY2023. As such, it plans to release tax-exempt income of $6.6million withheld in 4QFY2020 to unitholders during FY2023.
Koh calls MINT’s portfolio “resilient”, with occupancy for its data centres in North America standing at 94.2% as of March.
MINT has a long WALE of 6.1 years, and provides an average rental escalation of 2-2.5%.
Electricity prices will also have a minimal impact on MINT, as triple net leases account for all leases for data centres in Singapore and 90.2% of leases for data centres in North America, where the increase in the cost of electricity is less dramatic due to diversified sources of energy.
A catalyst for the data centre sector are continued growth from cloud service providers and social media companies. Land and power constraints are also another catalyst, as they restrict the supply of future data centres.
However, a risk that Koh identifies is that continued capitalisation rates reduce opportunities for yield-accretive acquisitions for the REITs.
At 1.13pm, units of DCR and MINT were trading at 75 US cents and $2.64 respectively.
