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Is Digital Realty Trust a Buy?

[Updated: Oct 08, 2020 ] Jun 03, 2020 by Dan Caplinger
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With the stock market having fallen so sharply during the first part of 2020, many investors looked for more defensive plays that could stand up to volatility. Real estate is a great source of diversification for investment portfolios, and the convenience of real estate investment trusts makes them attractive to those who already have brokerage accounts and want to branch out beyond regular stocks.

Many investors think of REITs as owning regular commercial properties, like office buildings or retail space. Digital Realty Trust (NYSE: DLR) is a different type of REIT, though, with an emphasis on owning and operating data centers and offering related information technology services to enterprise customers. Along with its data center assets, Digital Realty gives its clients co-location and interconnection capabilities to enhance their access to the cloud.

Even as some REITs have struggled due to worries about the coronavirus pandemic's impact on their business models, Digital Realty has held up well. That's making many investors wonder whether the data center REIT would make a good addition to their real estate investment portfolios.

Finding a place for all that data

Digital Realty Trust was founded in 2004, at a time when the internet was just moving into its second major growth phase. After the tech boom of the 1990s, which focused largely on building out and commercializing the internet through e-commerce, forward-looking technology companies started looking at the promise of collecting information on their customers and analyzing it for ideas on how to boost their profits. The internet made such information readily available, but finding a place to store it was a different thing entirely.

Digital Realty sought to become part of the fundamental infrastructure of the digital world, with a network of connected data centers that gave clients better and faster access to the internet and the growing number of cloud-based resources available to them. It now counts 267 data center properties among its portfolio holdings, located in 20 countries across six continents and covering 44 major metropolitan areas.

Investors like what they've gotten from Digital Realty Trust as well. The data center REIT has boosted its annual dividends for 15 straight years, becoming the fifth largest publicly traded REIT in the U.S. market. Core funds from operations have climbed at a 12% annualized growth rate on a per-share basis since 2005.

How has Digital Realty done more recently?

Even with its long-term success, Digital Realty has been vulnerable to cyclical weakness in data center investment. In 2019, core funds from operations were up less than 2% and year-over-year core FFO actually fell slightly in the fourth quarter of 2019.

However, Digital Realty has an aggressive strategic plan to get its momentum back. The launch of the PlatformDIGITAL global data center platform should extend the data center REIT's already impressive capabilities to keep existing customers happy and win new business. Meanwhile, strategic moves like its all-stock acquisition of Dutch data center services provider Interxion have given Digital Realty additional sources of new revenue.

Those efforts have been notable, but they haven't protected Digital Realty from all of the ill effects of the pandemic. Core FFO in the first quarter of 2020 dropped more than 5%, and an increase in outstanding stock sent per-share FFO figures down double-digit percentages. Yet the REIT's data centers have remained fully operational as essential operations, and although construction delays have slowed down some of its growth plans, Digital Realty is communicating well with its clients to ensure that it's meeting their needs.

Is now the time to buy Digital Realty Trust?

Digital Realty sees 2020 remaining difficult, projecting core FFO of between $5.90 and $6.10 per share. With most companies choosing not to offer any guidance for the full 2020 year at all, it's notable that the data center REIT is bucking that trend with its outlook. Even so, it'll be tough for investors to endure the roughly 10% decline from the $6.65 per share in core FFO that the REIT brought in during 2019.

Those who are willing to wait, though, should see long-term rewards from investing in Digital Realty. The data center REIT has overcome cyclical downturns before, and client retention has typically remained high. Digital Realty also pays a regular dividend, with a yield exceeding 3%. That's not as much as some REITs, but Digital Realty offers superior growth prospects compared to REITs in different categories -- especially now, and especially in comparison to REITs concentrating on retail properties.

The long-run picture for data centers is good, and that makes Digital Realty Trust worth looking at for those with the risk tolerance and the time horizon to endure short-term headwinds. The digital revolution shows no signs of slowing down, and that should keep demand for Digital Realty's data centers high for the foreseeable future.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Digital Realty Trust. The Motley Fool has a disclosure policy.