Since the IPO of Mapletree Industrial Trust (MINT) in 2010, the unassuming and soft-spoken CEO of MINT’s manager Tham Kuo Wei, has gradually increased the REIT’s exposure to data centres.
MINT’s knowledge of data centres started with the development of build-to-suit data centres in Singapore. MINT’s first build-to-suit data centre development was Tata Communications Exchange in 2010 (prior to the listing of MINT). The property has been rebranded as STT Tai Seng 1. In 2015, MINT completed another build-to-suit data centre, 26A Ayer Rajah Crescent for Equinix Singapore. In 2015, MINT started the redevelopment of a cluster of flatted factories at 1 & 1A Depot Close into a build-to-suit development for HP Inc which includes facilities for manufacturing, product and software development, customer service and an office. That project was completed in June 2017. In September that same year, MINT announced it was expanding its investment strategy to include data centres beyond Singapore. At that time, Tham had pointed out the need to expand into a jurisdiction which had data centres with long leases on freehold land to help improve the quality of the portfolio and stability of returns to unitholders.
A month later, MINT announced it had acquired a 40% stake in a portfolio of 14 data centres in the US, known as Mapletree Redwood Data Centre Trust (MRDCT), in partnership with sponsor Mapletree Investments in a 60:40 split.
MINT’s pivot towards data centres in 2015 and 2017 has now proven prescient. In a recent analyst briefing, Tham said, “Deals that are done now in the market aren’t priced competitively. The bigger challenge for us now is pricing and a very sharp compression in capitalisation rates. Some of these transactions that surface would be a bit difficult for us to do. There may not be as many opportunities as what we have seen in the last two years”
Tham says the disadvantage of increasing the REIT’s data centre portfolio in Singapore is two-fold. These are a shorter land lease and Singapore’s increasingly onerous regulations on emissions after the republic signed up to the Paris Accord. On the other hand, the US offers the largest established data centre sector in the world, with longer or freehold land tenures and Fortune 500 tenants.
In FY2020 and FY2021 ended March, which corresponded to the calendar years 2019 and 2020, MINT stepped up its investments in data centres. This year, MINT acquired the remaining 60% stake MRDCT.
The US data centres are scattered across nine states — some of which might have become familiar names to Singaporeans because of the recent US election. Three data centres are in Georgia, three in Texas, and two in North Carolina. The rest are scattered across Wisconsin, Michigan, Pennsylvania, New Jersey, Tennessee and California.
Sited on freehold land, 81.6% of the MRDCT portfolio by gross rental income (GRI) are leased on a core-and-shell basis with all tenants on triple net lease structures where expenses are borne by tenants, MINT says. The portfolio has a well-staggered lease expiry profile with 20% of leases expiring within the next three years. Based on GRI, 97.8% of the MRDCT portfolio has annual rental escalations of 2% and above, providing stable and growing cash flows. The top five tenants of this portfolio by GRI are AT&T, The Vanguard Group, General Electric, Level3 Communications and Equinix.
On June 22, MINT joined the Straits Times Index (STI), becoming one of only 30 stocks on the Singapore Exchange (SGX) and replacing Singapore Press Holdings (SPH). With that achievement, MINT is now a member of 28 indices, including the much-followed FTSE EPRA NAREIT Global REITs Index and the FTSE EPRA NAREIT Developed Index.
In a recent report, DBS Group Research pointed out that MINT trades at 1.9 times its NAV, which is higher than most REITs. In comparison, Keppel DC REIT (KDC REIT), which is a pure play data centre REIT with 18 data centres valued at $2.8 billion and situated in Asia Pacific and Europe, trades closer to 2.3 times its NAV. So is MINT undervalued?
The case for data centres
During much of this year, MINT has become a proxy play for the Covid-19 pandemic as people worked from home (WFH). Zoom, Google Meets, Webex and Microsoft Teams became household names.
“As the world grappled with the Covid-19 pandemic, with the closing of borders, curfews, lockdowns and other movement restrictions, digitalisation has come to the rescue. Online shopping and entertainment, digital financial services, virtual meetings and events have taken center stage in lives and livelihoods globally,” says an IMF report dated Nov 5.
Providers of cloud services, which are stored in data centres, continued to boom. According to Gartner, Infrastructure as a Service (IaaS) is likely to see the fastest-growing public cloud spending at 24% this year due to data centre consolidation. According to Cisco Systems, cloud data centres will process 94% of workloads in 2021.
“The onset of Covid-19 has triggered the acceleration of digital transformation. It has also highlighted the invaluable role of data centres as the central nervous system of the digital economy,” notes Mark Smith, managing director, Asia Pacific, at Digital Realty, one of the largest data centre REITs in the world.
That is all music to the ears of MINT’s unitholders. As at September 30, 20 data centres account for 38.7% of MINT’s $6.6 billion in assets under management (AUM). Of this, data centres in Singapore comprise 6.5% of total AUM, while data centres in US comprise 32.2% of AUM for US data centres.
In Sept 2019, MINT acquired 10 powered shell data centres and co-invested in three fully-fitted hyperscale turnkey data centres in North America via Mapletree Rosewood Data Centre Trust (MRODCT), a 50:50 joint venture with Mapletree Investments, for US$1.37 billion ($1.84 billion). MRODCT holds an 80% interest in the three fully-fitted hyperscale data centres in North America, with Digital Realty holding the remaining 20% interest.
The data centres are located in important markets in the US and Canada, with six properties in Northern Virginia, the world’s largest data centre market. The data centres are primarily on triple net leases with all outgoings borne by tenants. All properties in the MRODCT portfolio are 100% leased to nine established tenants such as software, social networking, cloud computing, consumer electronics and co-location companies, with long WALEs. The phased acquisition of MRODCT was completed in December 2019 and January this year.
Positive impact
The two acquisitions, which amount to a total of $2.13 billion based on their 32.2% share of AUM, had a positive impact on distributable income in both 1HFY2021 and 2QFY2021 ended Sept 30.
“In [2QFY2020/2021], revenue was driven by the 14 data centres we completed on Sept 1,” Tham said at MINT’s recent results briefing. “From a distributable income perspective, we have seen an increase of 14.8% to $72.9 million for the second quarter. Some of this comes from the additional 60% stake for one month, from Sept 1 to Sept 30, and some of the increase is partly from the acquisition of other data centre assets at the beginning of this year and end of last year,” adds Tham, referring to the remaining 60% stake in the MRDCT portfolio completed at end-August, and the acquisition of a 50% stake in the MRODCT portfolio announced last year, which was completed in phases.
The 50% stake in MRODCT portfolio was classified as an associate. Hence, it has no impact on revenue and net property income (NPI). Revenue rose 1.5% to $103.3 million in 2QFY2021 while NPI rose by a modest 2% to $81.6 million. Similarly, in 1HFY2021, revenue inched up 0.5% to $202.4 million and NPI increased by 1.5% to $160.2 million, but distributable income surged 13% to $143.4 million. Distributable income once again was underpinned by the contribution from MRODCT.
“In previous years, we did not have the second data centre portfolio which is a joint venture. As a result, there is a very large increase in distributable income,” Tham notes.
In terms of data centre pipelines, Tham says he “would look at the potential acquisition of the balance of the sponsor’s share of the portfolio acquired from Digital Realty.”
On Sept 14, MINT announced the sale, purchase and escrow agreement with a vendor for the purchase of a data centre and office in Virginia. The announcement gave the potential purchase price as a range between US$200.6 million and US$262.1 million. Independent valuer Cushman & Wakefield of North Carolina had valued the property at between US$205 million and US$266 million as at August 31.
The acquisition would lift the portion of data centre’s AUM in MINT’s portfolio to 41%, with North American data centres accounting for 34.7% of AUM.
The Virginia property is fully leased to an MNC with strong credit standing on a triple net lease structure whereby all outgoings such as maintenance, tax and insurance charges are borne by the tenant. The tenant is also responsible for the replacement of fit-outs until the end of its lease term of around five years. Such lease arrangement minimises the operating risks and the capital expenditure commitments of MINT, its announcement says.
The Virginia property, like most of MINT’s data centre portfolio in the US, is sited on freehold land. Upon completion, MINT’s freehold properties by land area will increase from 51.8% as at end June to 55.9% of the enlarged portfolio. Upon completion, the tenant will become the fifth largest tenant of the portfolio with a GRI contribution of 2.7%.
“The vendor is extremely careful about [NPI yield] information and we will want to lock away the commercial and financial parameters first before announcing anything. In terms of profile, it’s similar to what you would normally expect from a data centre with these quality of tenants and leases in place. The counterparty is a little sensitive about information being released ahead of time,” Tham says of the Virginia property.
“We are still looking for opportunities in key markets but there is nothing we are able to crystallise at this moment at a mature level where we are able to transform into a workable deal. A lot are RFPs (request for proposal) in the market,” he adds.
Roadblocks to new data centres
Tham says it is not easy to build new data centres in Singapore. “The moratorium put in place by government agencies means it is very difficult to get new data centres to be approved while demand is fairly strong. Therefore, to crystallise build-to-suits in the near term is very low because you can’t get agencies to go ahead. The market may only open up in mid-2021 and beyond.”
Lynus Pook, director, global data centre advisory group at Cushman & Wakefield, adds, “As Singapore ponders lowering national emissions and how best to combat climate change, the major power requirements of data centres have drawn considerable concern locally as they have around the globe. While other markets have been able to utilise hydroelectric or wind power to accommodate these issues, Singapore traditionally has had limited scope for change and relied on natural gas for most energy requirements. Current government plans to alleviate concerns by integrating more solar power are a start, but execution will prove difficult; the limited space for large solar deployments will do little for data centres that use the power of thousands of homes.”
Elsewhere, Keppel Data Centres has continued research into floating data centres, signing for feasibility studies with both Toll Group and Royal Vopak to explore the modular design aspects and liquefied natural gas power, respectively. Keppel Data Centres followed this up with another research agreement with Mitsubishi Heavy Industries to explore hydrogen power in data centre applications, and a further partnership with Chevron, Pan-United Holdings, and Surbana Jurong to investigate carbon capture technologies.
The National University of Singapore, Keppel Data Centres, and Singapore LNG Corp have joined forces to research new data centre cooling technology. An initial application (known as Semiclathrate Thermal Energy Carrier System) has the potential to boost data centre PUE by 20%, and further innovations will be studied. Meanwhile, Keppel Corp has agreed to form a joint venture with SPH to reconstruct a building on Genting Lane for data centre purposes, acquiring a 60% interest for $50 million.
Elsewhere, Singapore Telecommunications (Singtel) completed a major solar installation at their Bedok data centre in April, with the rooftop installation spanning over 8,200 sq m. Singtel partnered with SunSeap Global on the improvements, with the expectation that 10% of the overall load will be provided by solar power.
In addition, MINT in August had to agree to divest a data centre at 26A Ayer Rajah Crescent to Equinix. The property is a buid-to-suit data centre for Equinix, and Equinix had the option to acquire the property at the end of a five-year period. The saving grace is the sale price of $125 million, which is a 23.3% premium over the development cost of $101.4 million. The Ayer Rajah Crescent property contributed to 2.2% of MINT’s revenue in FY2020 ended March 31.
“We try not to embed this option because we want our portfolio to give us stability. We do not want the portfolio size to shrink but to expand over time,” Tham says. “It was financially meaningful for us when we did the [build-to-suit] transaction, and we were trying to build up capability and track record in this space,” he explains. MINT has Equinix as a tenant in 7 Tai Seng Drive and 180 Peach Street in Atlanta.
Challenges remain
Although demand for data centres continue to rise in the face of limited supply, the leases on MINT’s data centres are long, and most of the leases are on a core-and-shell basis. Hence, if the data centre operator’s businesses increase as a result of global digitalisation and use of cloud services, MINT’s rents are not really affected.
Moreover, since the onset of Covid-19 and government measures to support SMEs, MINT’s flatted factory sector is facing challenges. As at end September, about 54% of MINT’s Singapore portfolio by GRI, which is the equivalent of 40% of the overall portfolio, comprises SME tenants. Rental reliefs extended to tenants are estimated to amount to about $20 million, which will affect MINT’s distributable income for FY2021. This includes the Covid-19 Assistance and Relief Programme of up to $13.7 million.
“I will be hard pressed to identify certain bright spots,” Tham replies when asked which sectors are experiencing new leasing demand. The pertinent answer would be which sectors are less weak, he adds. These include biomedical, precision engineering and semiconductor sectors.
Upside to valuations
On the bright side, MINT’s data centre valuations are likely to remain robust. “Since buying our first data centre portfolio, when capitalisation rates were 6.9%, they are now 6% to 6.5%. For hyperscale facilities cap rates would be lower. In key markets, core-and-shell would be trending below 6%. If you have very established tenants in key locations, you would be pushing 5%,” Tham says.
DBS remains positive despite MINT’s challenges. It sees upside from the redevelopment of MINT’s Kolam Ayer 2 cluster. “We believe investors have not priced in the ‘value’ in MINT portfolio. The redevelopment of its ‘land bank’ of older flatted factories will drive portfolio gross floor area and drive medium-term growth in distributions and NAV, keeping valuations at a premium,” DBS says.
In July 2019, MINT announced the redevelopment of its Kolam Ayer 2 flatted factory cluster into hi-tech buildings. The project cost is about $263 million, and the redevelopment includes a built-to-suit facility for a global medical device company headquartered in Germany which will account for about 24.4% of redeveloped GFA. The original plot ratio was 1.5 times and will increase to 2.5 times, or 865,600 sq ft. “[The redevelopment] allows us to increase the plot ratio by 1.0 and leasing demand continues to be encouraging,” Tham says.
DBS is forecasting a 2% decline in DPU for FY2021, to 12 cents. Although MINT’s 1HFY2021 DPU fell by 4% to 5.97 cents, 2QFY2021 DPU was only 1% lower at 3.1 cents. If this trend continues in 2HFY2021, MINT could almost match FY2020’s DPU of 12.24 cents.
Still, Tham sounds cautious on the outlook, “It’s difficult for us to say we’re completely out of the woods. A lot of tenants are still cautious and we may see certain industry segments that are seeing a return of demand, but a lot of tenants are still taking a wait-and-see approach.”
Whatever the case, the data centre portfolio is likely to play an increasingly larger role in MINT’s future growth. “The US and North American portfolio is a very resilient property segment. There is very strong demand for data centre needs,” insists Tham. In 2QFY2021, MINT’s NAV rose 4.3% q-o-q to $1.69 and this trajectory may well be what investors will focus on with MINT now in the STI.
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Understanding the tier system
Based on Uptime Institute’s Tier Certifications system, which has become the default standard for the data centre industry, data centre classifications are divided into four tiers that match a particular business function and define criteria for maintenance, power, cooling and fault capabilities.
A Tier I data centre is the basic capacity level with infrastructure to support information technology for an office setting and beyond. Tier I protects against disruptions from human error, but not unexpected failure or outage. Redundant equipment includes chillers, pumps, UPS modules and engine generators. The facility will have to shut down completely for preventive maintenance and repairs, and failure to do so increases the risk of unplanned disruptions and severe consequences from system failure.
Tier II facilities cover redundant capacity components for power and cooling that provide better maintenance opportunities and safety against disruptions. The distribution path of Tier II serves a critical environment, and the components can be removed without shutting the system down. Like a Tier I facility, unexpected shutdown of a Tier II data centre will affect the system.
A Tier III data centre is concurrently maintainable with redundant components as a key differentiator, with redundant distribution paths to serve the critical environment. Unlike Tier I and Tier II, these facilities require no shutdowns when its equipment needs maintenance or replacement. The components of Tier III are added to Tier II components so that any part can be shut down without impacting IT operation.
A Tier IV data centre has several independent and physically isolated systems that act as redundant capacity components and distribution paths. The separation is necessary to prevent an event from compromising any of its systems. The environment will not be affected by a disruption from planned or unplanned events. However, if the redundant components or distribution paths are shut down for maintenance, the environment may experience a higher risk of disruption if a failure occurs. Tier IV facilities add fault-tolerance to the Tier III topology. When a piece of equipment fails, or there is an interruption in the distribution path, IT operations will not be affected. All of the IT equipment must have a fault-tolerant power design to be compatible. Tier IV data centres also require continuous cooling to make the environment stable. — EdgeProp Malaysia
Glossary of terms
PUE
This is a ratio defined as the power used by a data centre divided by the power used by its IT equipment. Specifically, it shows how much power is used by the actual IT equipment compared with the power used by all the data centre’s services, which also includes cooling, lighting, power network equipment and so on. By adopting best practices, it is possible to reach an average annual PUE of 1.1 and even lower.
Hyperscale data centres
The increasing adoption of cloud services have led to the growth and development of large-scale data centres, or hyperscale data centres (HDCs). These HDCs enable seamless scalability of computing tasks by incorporating individual servers that operate together over high-speed networks, with a robust and flexible system architecture. HDCs have become critical infrastructure for the world’s largest cloud services companies, as well as for corporates that are increasingly adopting cloud-based applications.
Turnkey real estate
This typically refers to investment properties that are already rehabbed, tenant occupied, have management in place, and are producing positive cash flow. The term comes from the idea that you can “turn the key” in the door and walk right on in
Powered shell
Powered shells are buildings newly constructed or retrofitted specifically for data centre development. These facilities are typically powered by two electrical feeds from one or two separate substations, and connectivity is within close proximity. The powered shell strategy provides a phased approach to development. Many data centre operators deploy this strategy to conserve capital and give themselves the flexibility needed to adapt with users’ needs in mind. The powered shell approach is advantageous to the end user because of design input, speed to market, and control. — compiled from various reports
