Industrial real estate has been one of the top-performing commercial real estate sectors over the past few years. Strong performance, high demand, and resiliency during troubling economic times makes it an appealing asset class for real estate investors. One subsector of industrial real estate that has fared particularly well is data centers. Digital Realty Trust (NYSE: DLR) is one of the leading data center real estate investment trusts (REITs), making it an accessible way to participate in this growing sector. But with share prices up significantly this year, let's see if it's still a buy today.
The need for data storage isn't going away anytime soon
Ever heard the term "in the cloud"? Software or online services that operate on the internet instead of locally are cloud-based services, which require the data necessary to run the program to be safely stored and available for use. That's where data centers come into play: A data center safely stores data. But data centers don't stop there. Healthcare, social media, the financial industry, and other technologically based industries require data centers to operate.
Digital Realty Trust originally became public in 2004 and has since grown into a giant, not just among data centers, but among all REITs. It now holds the title of the fifth-largest publicly traded REIT in the U.S. and has 280 properties under management in 22 countries on six different continents.
The case for Digital Realty Trust
The company has a great rack record, with 15 years of consecutive dividend increases and 12% share growth since 2005. It also has a large market share of data centers and is rapidly growing. In third quarter 2020, the company added or expanded assets in Croatia, Madrid, and Toronto. These projects, in addition to another $2 billion currently under development, should bring in additional revenue for the company.
Additionally, its financials appear strong, with a debt-to-EBITDA ratio of 5.7 times and no debt maturities until 2022. The company places a large effort in renewable energy, helping supply and subsidize a portion of its data center's energy needs from solar or wind power in certain markets, which will help keep costs down. Its conservative payout ratio of 72% means it can maintain its dividends and cover its debt obligations in the event of a downturn.
The case against Digital Realty Trust
As of second quarter 2020, occupancy was at 86%, with 59% of all data centers under development being preleased. Market absorption has been a growing concern in the data center sector, especially amid economic concerns relating to COVID-19. With core funds from operations (CFFO) down 8.6% for the six months ended June 2020 when compared to the same six months prior, concern over sustainability is understandable.
While other stocks and REIT values plummeted, Digital Realty trust gained roughly 11% from its February high at the time of this writing. That means current returns for investors is below 3%, in line with returns among other data center REITs. While the current share prices are a hard sell, the company has a lot of room to grow in the future. Despite dips in the data sector, I believe its plans for expansion will help them compete in the space while meeting ongoing demand.
For those looking for a consistent return in an expanding industry and have a long-term outlook, I think Digital Realty Trust is a good buy. Its third quarter 2020 earnings will be reported at the end of business day on October 29, 2020, and will help provide more insights into the company's recent performance and forward-looking statements.
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