Digital Realty (DLR 0.39%) has an elite track record of paying dividends. Last year was the data center operator's 17th straight year of increasing its payout. That kept it in a select group of REITs that have given investors a raise every year since going public. 

But the data center REIT faces several headwinds that put its high-yielding dividend at risk of being cut. Management is working to avoid that scenario by completing a $2 billion capital recycling strategy. Here's a closer look at Digital Realty's issues and its plan to address them and preserve the 4.9%-yielding dividend.

Battling a barrage of headwinds

Foreign exchange rate fluctuations have been causing some headaches for Digital Realty, and they continued to plague the company in the first quarter. The REIT reported $1.66 per share of core funds from operations (FFO) in the quarter, down from $1.67 per share in the prior year. That decline was due in part to foreign currency shifts. Core FFO would have been $1.69 per share on a constant-currency basis in the quarter. 

Rising interest rates are weighing on its FFO too. The company's interest expense was $102 million in the first quarter, up from $67 million in the year-ago period. That was due to a combination of an increase in total debt and the impact of higher rates on its floating rate debt. 

These headwinds also took a bite out of its adjusted FFO, which is the money it can use to pay dividends. That was even lower at $1.56 per share, and down from $1.59 per share in the prior-year period. That increased the company's dividend payout ratio to 78.2%, up from 76.7% in Q1 2022.

Digital Realty ended the first quarter with about $18 billion of debt, putting its leverage ratio at 7.1 times net debt to adjusted EBITDA. That's well above the company's target ratio of around 6. 

With its dividend payout and leverage ratio rising, Digital Realty has less financial flexibility to fund its development programs. That's a concern given that the company expects to spend between $2.3 billion and $2.5 billion on development this year. 

A plan to fund its expansion

Digital Realty plans to fund its expansion program by recycling capital, a strategy that will also get its leverage ratio down toward its target level. The management team discussed that strategy on its recent first-quarter conference call. CFO Matt Mercier stated: "Our capital plan ... as we laid out last quarter ... is based on ... $2-plus billion of capital recycling from our joint-venture opportunities, as well as the potential for non-core dispositions."

The company wants to sell around $2 billion of assets this year. It will recycle that capital into its development investments. This plan will allow it to fund new developments while lowering its leverage ratio toward its 6.0 times target.

CEO Andy Power noted on the call that 75% of that target would come from sales of stabilized joint ventures and development projects. The balance will come from non-core asset sales.

"We remain confident in our funding plan for 2023," stated Jordan Sadler, senior vice president of investor relations, in leading off the call -- a sentiment that was echoed by Mercier and Power later on in the call. "We are deeply engaged in the process with multiple institutional buyers, including new and existing partners, and we'll update you on specifics once we finalize the transactions," Sadler continued.

Those discussions and recent deal pricing are driving management's confidence in its ability to execute the funding plan for the year. For example, Power pointed out on the call that the recent sale of a European data center operator to a leading institutional investor was at a value consistent with other similar sales in recent years. Because values are holding up and institutional investors remain eager to do deals in the sector, there's a higher likelihood that Digital Realty will be able to complete its funding plan. 

Confident in completing its plan

Digital Realty's stock has been under a lot of pressure over the past year, weighed down by concerns about its balance sheet and capital spending. Investors remain worried that the company might need to cut its dividend if it can't complete its funding plan.

However, management remains confident they can execute about $2 billion of transactions this year. That would give it the capital to recycle into its development program and reduce its leverage, taking the pressure off its dividend. Investors should monitor the company's progress in executing this strategy, given its importance to preserving the dividend.