Digital Realty REIT captures AI growth

Canadians tend to think local and traditional when it comes to Real Estate Investment Trusts. We tend to prefer REITs that operate in our own backyard, whether it’s office buildings, rental apartments, or shopping centres.

While some of these trusts are a good bet, the artificial intelligence boom is creating demand for so-called new economy REITs. These own datacentres where companies crunch their data, store the information, and are assured of an environment that expands with their needs.

Such REITs offer conservative investors a way to piggyback on the growth of AI in a less risky way. While Nvidia, IBM, Microsoft and Alphabet grab the AI headlines, these  out-of-the-limelight companies are vital to their clients’ success. 

Traditional data centres can be the size of a warehouse, but newer hyperscale facilities are much bigger. They can accommodate tens of thousands of servers and rapidly scale up as a client’s demand increases. Hyperscale data centers can have 5,000 or more servers and sometimes miles of wiring and connections to keep it all running. They have dedicated sources of power and backups to minimize down time.

For example, New York-listed Digital Realty Corp. (NYSE: DLR) discussed below has a facility just north of Toronto, in Vaughan, that is the size of 12 football fields.

Digital Realty Trust Inc. (NYSE: DLR)  Recent price $161.21 All figures in US dollars.

Background: Digital Realty is a giant in the data centre world with a market capitalization of $50 billion and about 9% of the global market share for data centres. These temperature-controlled facilities have secure internet connections and high levels of data security. The facilities are used for cloud computing, artificial intelligence, and the Internet of Things.

The San Francisco-based company has been public since 2004. Its portfolio includes 300 properties in 14 countries on five continents. The US and UK are its top markets. Its three Canadian facilities are in the Toronto area, one downtown, another in Markham, and the third, the largest, in Vaughan.

Digital Realty’s clients are a Who’s Who of the technology world, including Microsoft, Facebook, IBM, Apple, Google, and LinkedIn. 

Performance: The shares up are 17% year-to-date and 37% in last 12 months.

Recent developments: Digital Realty’s first quarter results were outstanding and a hard act to follow. The second quarter ending July 25 was not as good, but still strong.

The REIT paid down nearly $1 billion in debt during the quarter. It added new bookings worth $164 million. Average lease renewals were about 4% higher than a year ago. Funds from operations (FFO) a key measure for REITs, was $1.65 per share, ahead of estimates. 

Discussion: Digital continues to buy land in global centres and build new facilities. RBC Capital Markets analyst Matthew Dolgin said in a recent research report that Digital Realty has transformed from a business providing large companies with vast amounts of space and power to one with a much higher value-added. It offers the full spectrum of space, power, and connection needs. This means it will benefit from three trends: creation and use of data, which is only exacerbated by artificial intelligence; the need for that data to be connected; and reliance on cloud providers. Its global presence gives it an advantage over its competitors.

Digital Realty’s price-to-earnings ratio of 44.99 is higher than many of its competitors, indicating confidence that it can continue to capture AI growth.

Digital raised its payout each year between 2015 and 2022, averaging 11% a year. It has not increased its distribution since 2022 as the quick rise in interest rates and its expansion plans created a need for capital. The current annual rate is $4.88, yielding 3.1% at current prices.

Distributions received in a non-registered account or a tax-free savings account will be subject to a 15% withholding tax. Payments to RRSPs and RRIFs are not subject to the tax.

As demand for data storage grows Digital Realty is well positioned to maintain its dominance. It has geographic diversification, will benefit from falling rates, and if the economy slows, few clients are likely to trim their web and related online activities.

This article appeared in a recent issue of the Income Investor.  For information on how to reprint this article please view this page.