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Are data centre REITs undergoing a reboot?

Goola Warden
Goola Warden • 13 min read
Are data centre REITs undergoing a reboot?
Digital Core REIT and Digital Realty own 25% and 75% respectively of this Frankfurt data centre / Photo: Digital Realty
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Data centres are in demand, driven by the increased adoption of technologies such as cloud services, machine learning, artificial intelligence (AI), generative AI (GenAI), and perhaps even quantum computing, data analytics and the Internet of Things (IoT). The list goes on.

Just imagine anything on social media goes on the cloud. According to DataReportal and Demandsage, as of October 2023, there were 5.3 billion Internet users worldwide, which amounted to 65.7% of the global population. Of this total, 4.95 billion, or 61.4% of the world’s population, were social media users. The global social media users are forecast to reach 5.17 billion by the end of 2024. Facebook is the biggest social media platform, with 3.05 billion users.

No surprise then that entities such as Prologis, better known as a logistics REIT, and fund manager Blackstone are muscling in on building and acquiring data centres through joint ventures with data centre operators.

But tech companies, big and small, are announcing job losses, and some are also giving up space here in Singapore and elsewhere. These can be for a myriad of reasons. As part of its digital transformation programme, AT&T shed more than 10,000 jobs in the first nine months of 2023.

During a results briefing on Feb 1, William Tay, CEO of CapitaLand Ascendas REIT A17U -

’s (CLAR) manager, acknowledged that tech companies are shedding space when asked about tech demand. “There is no surprise. It is not here in Singapore alone. It is almost everywhere that we see there is no tech demand. Any tech demand that we see comes in small quantities or very small sizes or specialised tech. It’s not Big Tech. Big Tech is looking for its shadow space to be leased out.”

Singapore-listed data centre real estate owners have not been immune to the shifting sands of the tech sector with its constant wave of restructuring, innovation, consolidation and job losses. S-REITs such as Digital Core REIT (DC REIT), Keppel DC REIT (KDC REIT), Mapletree Industrial Trust ME8U -

(MINT) and CLAR have had to grapple with the dislocations caused by the tech sector along with inflationary pressures and, most of all, higher interest expense as a result of the accelerated rise in US federal funds rate (FFR) from 0%–25% to 5.25%–5.5% in two years.

Listed S-REITs face challenges

REIT managers acknowledged that the past two years have been difficult as the interest rate cycle lowered their capital values, just as their tenants downsized or resized.

CLAR acquired a portfolio of data centres from Digital Realty in Europe and the UK in 2021 for the equivalent of $904 million and a colocation facility in Watford for a tad under $200 million. Tay revealed that the Watford data centre — acquired at a capitalisation rate of 9%–10% — is likely to be the subject of an AEI (asset enhancement initiative). CLAR is applying for a higher power capacity of 60MW as it seeks to redevelop the property.

See also: SGX RegCo makes statement on who can vote at Sabana REIT’s EGM as manager clarifies current external model to unitholder

Meanwhile, the valuation of CLAR’s business parks, whose tenants are mainly tech and medtech companies, was revalued lower to US$1.55 billion as at December 31, 2023, down 19% y-o-y when measured in US dollars. However, its portfolio of 227 properties valued at $16.9 billion managed to eke out a small valuation gain as declines were offset by valuation gains elsewhere.

MINT’s manager had flagged that one of its tenants, AT&T, was unlikely to renew its lease at two properties. These were 402 Franklin Road, Brentwood, in Tennessee which contributed 1.8% to GRI (gross rental income) when tenanted, and a smaller property, Riverwood Drive, Pewaukee, in Wisconsin. AT&T’s departure led to MINT’s occupancy in its US portfolio falling to 89.9%.

Discussions for a prospective tenant to take over the entire property at Brentwood are in the advanced stages of negotiation. Discussions with a prospective tenant for the Pewaukee property are ongoing but it is not as advanced as that of the Brentwood property. In FY2023 ended March 2023, AT&T contributed 5.4% to MINT’s GRI.

Cyxtera Technologies’ bankruptcy and subsequent restructuring involved MINT and Digital Core REIT as it was a major tenant at the properties of both REITs. Cyxtera contributed 3% to MINT’s GRI as at Sept 30, 2023, and 22% of DC REIT’s GRI based on its FY2022 revenue.

Cyxtera used to occupy eight data centres in MINT’s portfolio, of which seven were held under the Mapletree Rosewood Data Centre Trust, a 50:50 joint venture with Mapletree Investments. Following the restructuring, except for two, there were no changes in six of the leases.

In November, Digital Realty, Brookfield and DC REIT agreed on Cyxtera’s reorganisation (see DC REIT story on Page 7). As part of the reorganisation, DC REIT divested 2401 Walsh Avenue and 2403 Walsh Avenue in Silicon Valley to Brookfield for US$160.2 million ($215.33 million) at book value, which is lower than the purchase price of US$181 million as disclosed in the REIT’s 2021 prospectus. Two of Cyxtera’s leases in Los Angeles were assigned to Brookfield.

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Challenges in China

Much has been made of the developed world’s tech challenges because of the digital transformation in its tech sector. But what is going on in China?  

On Jan 26, Loh Hwee Long, CEO of the manager of KDC REIT, spent more than an hour answering questions about the REIT’s two data centres in China, Guangdong Data Centre (GDC) 1 and 2. The developer and master lessee of the two properties was in arrears to the tune of four months and around RMB48.3 million ($9.1 million).  

Guangdong Bluesea Data Development Co (Bluesea), the developer and master lessee of  GDC 1 and 2, is a unit of Hong Kong-listed Neo Telemedia. KDC REIT agreed to acquire GDC 3 for $148.5 million which the seller had been fitting out at the time. As at Dec 31, 2023, GDC 3 was carried in KDC REIT’s books at $12 million as the REIT has not paid in full for GDC 3.  

Loh says it made more sense to be working on a roadmap with Bluesea rather than start litigation despite Bluesea being in arrears as litigation can be a very long-drawn process. “Based on our current assessment, the recovery roadmap is going to be the optimal way for us to move forward to work towards the recovery of rental arrears as well as working collaboratively with the tenant to ensure the recovery of rental arrears, top up of security deposits and the tenant being current with rental obligations,” he says.

“While the underlying tenants are China’s major telcos, the ultimate end-users are retail enterprises. We see current headwinds at the macro level. In the past, apart from Covid, there were also some market developments such as the clampdown of the gaming sector and bitcoin mining business which had impacted the underlying performance of the assets,” Loh explains when asked about the outlook in China.

For REITs, data centre assets are valued in a couple of ways. The key method is discounted cash flow (DCF) where data including operating cash flow and cost of debt are used along with a discount rate to obtain a net present value. KDC’s Guangdong data centres have not been revalued lower as at Dec 31, 2023.

Operators and REITs

The data centre scene is a bit like the hotel and hospitality arena. Hotel management companies such as Hilton, IHG, Accor and Marriott manage hotels owned by landlords such as Frasers Hospitality Trust ACV -

or OUE LJ3 - REIT.  Similarly, companies such as Equinix, Skybox, Digital Realty, CyrusOne, Switch, QTX, NTT, Alibaba (and Cyxtera Technologies) are some well-known operators.

In the US, data centre REITs such as Equinix and Digital Realty have elected to operate as REITs for US federal tax purposes. They are required to pay 90% of taxable income to shareholders annually. As internally managed REITs they can own operating companies and pay regular quarterly distributions to shareholders.

John Stewart, CEO of Digital Core REIT’s manager, which is a unit of Digital Realty, says: “US REITs are internally managed rather than externally managed so they don’t require a trustee to contract on their behalf and they are much more of an operating company.”

S-REITs are structured a little differently. The likes of KDC REIT, MINT and DC REIT are the real estate owners rather than operators. Their sponsors such as Digital Realty and Keppel Corp are the operators. Digital Realty also has a joint venture with MINT.

One of the challenges that operators face is the availability of power. Here, Keppel’s management believes it is at an advantage. “The key contribution for Keppel is we are at the leading edge in developing solutions that would lead to more energy-efficient data centres. This is something Keppel Data Centre (Keppel DC) and Keppel have been working on for years. It’s not something new and that puts us in a very strong position,” says Loh Chin Hua, group CEO, of Keppel, at a recent results briefing.

New floating data centre modules can be developed and deployed at Keppel DC’s Floating Data Centre Park (FDCP) using seawater for cooling. In addition, Keppel has signed various MOUs to use hydrogen for power. “We have an infrastructure division that looks at renewable energy. All these put us in a very strong position to solve this challenge to provide more computing power for data centres, making them more sustainable. Data centres are also quite capital-intensive. We have a well-proven ecosystem of capital recycling. We have private equity funds to invest in the development stage and can offer the data centre to the REIT when it has stabilised,” Loh explains.

The likes of Bursa-listed YTL Power are also muscling in on the data centre scene in Singapore. In 2021, its unit, YTL Data Center Holdings, acquired Dodid, a data centre that YTL says “serves the largest hyperscale customers in Asia”. In 2022, YTL announced it was developing a data centre park in Johor.

Back in the USA

In 2021, Prologis tied up with Skybox. According to Cushman & Wakefield (C&W), the duo received approvals for a 600MW campus that will total 3.9 million sq ft within a 150-acre site that the partnership acquired in Hutto, Texas, in 2022. Development plans are near completion at the 30MW site, C&W says.

Then, on Dec 7, 2023, Digital Realty and Blackstone announced that Blackstone-affiliated funds had agreed to establish a joint venture with Digital Realty to develop four hyperscale data centre campuses in Frankfurt, Paris and Northern Virginia to support 500MW of total IT load when all the campuses are fully built-out. Blackstone will own 80% of the JV for around US$700 million of initial capital with Digital Realty at 20%. Digital Realty will also manage the operations of the data centres.

In 2021, Blackstone acquired QTS Realty Trust, a data centre operator, for US$10 billion. Bloomberg has reported that QTS itself is developing US15 billion of properties compared to US$1 billion at the time of acquisition.

Is there enough demand?

In a report dated November 2023, S&P Global Intelligence says: “Demanding types of workloads such as high-performance computing (HPC), have had a place in data centres for years. Their implementation has often involved modifications to the rack or the facility to enable efficient power and cooling for the high-density infrastructure.”

S&P adds: “Widespread, accelerated adoption and use of AI could transform the data centre industry, as AI infrastructure requires more energy and more efficient cooling. There was already no shortage of demand for large-scale data centre capacity, and so far, AI seems to be adding to it.”

Mapletree Investments’ latest issue of Mapping (Nov 2023 to Jan 2024) quotes DC Byte stating that the global colocation data centre market is poised for further growth “with revenue projected to increase at a compound annual growth rate of 11% between 2020 and 2026”.

On the other hand, CBRE says demand for capacity in Europe is high although a lack of available power across metro markets is expected to inhibit growth to varying degrees. Some organisations are likely to look for capacity in new areas where supply can be more easily sourced, and the cost of power is lower, CBRE says.

It was only in 2022 that Singapore lifted a moratorium on data centre development which had been in force since 2019. The capacity to be shared among three developers is 80MW.  “Governments (and utilities) have restricted data centre development in Dublin, Singapore, the Netherlands, Beijing and Shanghai. Partly in response to these dynamics, the industry is becoming more efficient and expanding its use of renewable energy, with hyperscale cloud and IT providers leading the way,” says CBRE.

Despite funds and operators building more capacity, hyperscalers including tech giants like Amazon’s AWS, Microsoft Azure, Google Cloud, Meta Platforms, Apple, Alibaba, Tencent and TikTok, are building their own data centres. Google owns at least one data centre in Singapore.  

In a 2023 report, McKinsey says that based on data up to 2022, hyperscalers are likely to spend US$9 billion to build more capacity with the sum expected to grow by more than 4%. “Such plans face headwinds. The labour market is tight, commodity prices volatile, inflation high, and supply chains constrained, so global capital costs for construction projects have risen by at least 6%,” McKinsey says.

A handful of the hyperscalers have cut jobs since 2023, blaming the cuts on over-hiring, rapid hiring and the economic slowdown. None of the hyperscalers have blamed AI, GenAI or machine learning for the cuts in staffing. Instead, these technologies may require more power.

S&P Global identifies AI and GenAI as a major driver of data centre usage. “Most of the AI workloads today live in the cloud, so any amount of AI growth will inevitably fuel further cloud growth, which we are seeing in projected cloud revenue as well as the amount of data centre capacity cloud providers seem to be planning to add,” S&P Global says.

It is widely understood that GenAI takes additional power (a bit like bitcoin mining) and the extra co-pilot GenAI key on Microsoft’s new keyboard could cause the batteries of laptops to run down.

Over at KDC REIT, Loh Hwee Long, CEO of its REIT manager, says “Our current data centres can handle cloud deployments of AI models which generally have more stringent latency requirements.”

He believes KDC REIT’s portfolio has a sufficient cushion to weather its challenges in China. “The majority of our rental income is derived from clients with investment grade or including credit profiles. The portfolio asset valuation remains stable y-o-y at $3.6 billion. We continue to see stronger valuation outcomes from our assets in Singapore, Australia, Ireland, Italy and the Netherlands, which are driven mainly by very strong local market fundamentals and growth prospects,” he says.

With GenAI as an additional driver to cloud demand against a background of limited supply, it’s no surprise that Prologis and Blackstone want a slice of the action.  

 

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