To The Moon

Data centres were hot in the past few years as investors bet on the increasing cloud and data demand in the tech era. Very few investors believe that the bet will go wrong simply basing on the premise that 'this is the future'.

Well. Things went south after the Covid boom for data centre REITs.

Keppel DC REIT (AJBU)$KEPPEL DC REIT(AJBU.SI)$share price peaked around the second half of 2020 with a price of $3.04 and thereafter it gradually fell to $1.97 in Jul 2022. That's a 35% decline and the dividend yields weren't sufficient to cover this drop as they were less than 10% in the past 2 years.

The other pure play data centre REIT listed in Singapore is $DigiCore Reit USD(DCRU.SI)$Digital Core REIT (DCRU). It IPO-ed in end 2021 to much fanfare - share price jumped 15% higher than the IPO price of US$0.88 on the first day of trading.

It peaked at US$1.18 before crashing to US$0.76, a 36% decline in just 7 months of trading.

There were reasons for the fall.

First is that the interest rate has been rising and that hurts REITs because they borrow to fund real estate investments. Their financing costs would go up and reduce dividends.

The damage was larger against the data centre REITs because they were relatively more expensive than the other types of REITs - their dividend yields were lower.

For e.g. Keppel DC REIT average 5y dividend yield was just 3.38%. And with the 10y Singapore Government Bonds edging close to 3%, it doesn't make sense to take on higher risk with the REIT for about the same yield.

Hence, Keppel DC REIT share price has to fall in order for the dividend yield to go up.

Same goes for Digital Core REIT, which is more sensitive to the US rates as the data centres and financing are located in the US.

The second reason is more specific to DIgital Core REIT. Its fifth largest tenant has filed for bankruptcy. It contributed about 7% of Digital Core REIT's revenue. This would impact the dividend payout if the rental payment halts.

The third reason could be the fact that a hedge fund manager, Jim Chanos, openly said he is shorting data centre REITs that have no exposure to the big tech. (He became famous after shorting Enron and got it right.)

His argument against these REITs is that the big tech cloud businesses are going to gobble up the market share as they build their own sophisticated data centres and offer the services directly to customers.

He has a point and I think some demand can be impacted as customers subscribe to the cloud services and give up hosting their own servers. But I would think that it is mostly for the small and mid-sized companies where they don't have the scale to justify for managing their own physical servers. Subscribing to cloud services directly yields cost savings.

But for bigger companies where they may even rival certain services against the big tech, would prefer to own their servers and have more control. Sometimes privacy and data protection is a key consideration too. Data centre REITs provide the space needed for housing these servers and hence I believe there will still be demand.

Keppel DC REIT and Digital Core REIT are currently yielding about 5% and 5.4% respectively.

You are likely to buy if you believe in the following:

- data centre REITs are relevant in the future

- the current yields are attractive enough

- interest rates unlikely to rise significantly

I often hear people say this, "I will buy if the price comes down". But when it happens, some still don't dare to pull the trigger because there's bad news. It should be clear to you that they come as a package.

The key is to stay objective and determine if the bad news are permanent or temporary. Stay away if it is the former and have the courage to buy if it is the latter. I see the bad news for data centre REITs as temporary. What do you think?