Digital Realty: The REIT Way to Play Data

10/28/2013 8:00 am EST


Genia Turanova

Editor, Leeb Income Performance


Interest rate sensitive stocks had some tough going this summer. A flipside of this is that many REITs have come down to earth and now sell at more reasonable valuations, suggests income specialist Genia Turanova in Leeb Income Performance.

Digital Realty REIT (DLR) is one of them. However, as most experienced investors know, low valuation alone is never enough to entice buyers. There has to be a set of other factors coming together to overcome headwinds that had brought valuations to their low level in the first place.

Digital Realty provides data center platform service in a market with very high barriers for entry for telecommunication network providers (27% of annualized rent), IT service companies (29%), financial services (19%), internet enterprises (7%), and the other corporations covering the balance.

By geographic origin, 80% of its rents are from North America, 18% from Europe, with the small balance from Asia.

Future growth will come from both growth in data and the evolution in information technology. For the former, growth has been exponential, related to proliferation of mobile data and content, record-keeping and email retention for corporations, social networking, and electronic exchanges, to name just a few.

Digital Realty, despite its unconvincing price performance, is positioned for growth in data demand, which is expected to continue.

Indeed, it has delivered compounded annual FFO (funds from operations) growth per diluted share of 18.4% from 2005 to 2012, and of 11.2% in the second quarter of this year, compared to the same quarter of 2012.

As this is a company highly leveraged to modern technology trends, both threats and opportunities rest in the future developments of data-center technology. Current valuation, however, discounts a significant slowdown, and to us, does not look justified.

The only REIT with investment-grade debt, Digital Realty has a conservative capital structure. While this might not create enough leverage, it also leaves enough options for the company, if and when it should need additional borrowing.

Recently, moreover, Digital Realty announced a $369 million joint venture deal with Prudential Real Estate Investors, a real estate arm of Prudential Financial, in which it will retain a 20% interest.

The joint venture, in addition to raising Digital's profile, should prove to market participants the significant value of the data centers it already owns.

A recent 6.8% dividend increase continued the tradition of dividend growth for Digital Realty. We like the REIT at current levels, and its 5.6% yield is appealing too.

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