Say you, say me
Say it for always
That' s the way it should be
Say you, say me
Say it together, naturally

I had a dream, I had an awesome dream
People in the park playing games in the dark
And what they played was a masquerade
And from behind the walls of doubt
A voice was crying out

Concerns about unsustainable yields, tenant concentration risks, and the direction of long-term global interest rates may be weighing on its performance

 

[SINGAPORE] It was a good week for investors in the Singapore market, except perhaps for those who took a chance on the initial public offering (IPO) of NTT DC Real Estate Investment Trust (Reit). 

 

The much-hyped data centre trust, which began trading last Monday (Jul 14), ended the week at US$0.95 &ndash or 5 per cent below its IPO price of US$1. 

 

With its focus on a hot asset class, and GIC among its cornerstone investors, NTT DC Reit drew a lot of attention when it launched its IPO. Based on the nearly 599.9 million units available, the offering was approximately 4.6 times subscribed. An additional 51.5 million units were over-alloted. 

 

NTT DC Reit also came to market at a seemingly opportune moment. For one thing, the Straits Times Index (STI) has been on a tear since the Liberation Day sell-off in April, and has closed above the 4,000 mark on every trading day since Jul 2. 

 

On Friday, the local-market benchmark closed at 4,189.50, up nearly 2.5 per cent for the week. 

 

There has also been ample appetite in the market recently for Reits that own data centres. In fact, among the seven Reits that are components of the STI, the best performer last week was Keppel DC Reit (KDC) &ndash which rose 4.1 per cent.

 

This bump might have been partly due to Maybank initiating coverage on KDC, with a 12-month target price of S$2.40. In a report dated Jul 17, the research house said that KDC &ndash which holds 24 data centres across 10 countries, worth some S$5 billion &ndash is set to benefit from big trends such as digitalisation, cloud migration and the adoption of artificial intelligence. 

 

Maybank is forecasting KDC&rsquo s distribution per unit (DPU) to grow 4.9 per cent a year to 2027, driven by rent escalation and acquisitions. KDC closed Friday at S$2.28, which reflects a 2024 DPU yield of 4.1 per cent.

 

By comparison, NTT DC Reit holds six data centres with an appraised value of nearly US$1.6 billion. At its IPO price, it is forecast to deliver an annualised distribution yield of 7.5 per cent for the nine months to Mar 31, 2026 and a distribution yield of 7.8 per cent for the full year to Mar 31, 2027.

 

So, why did NTT DC Reit have such a lacklustre debut? Where are all the investors who tried to get their hands on its units during the offering? Why is the market not excited about its high projected distribution yield?

 

Rising risks for S-Reits

One concern I keep hearing is that NTT DC Reit&rsquo s projected yield may not be sustainable &ndash because it is based on a 100 per cent payout of its distributable income, and the Reit&rsquo s capital expenditure requirements may rise in the future.

 

Another concern is that NTT DC Reit faces tenant concentration risks, with its top 10 tenants accounting for 62.6 per cent of its monthly base rent. Worse, its largest tenant &ndash described in its prospectus as a Fortune 100 US automotive company &ndash accounts for 31.5 per cent of its total monthly base rent. 

 

Many market watchers assume that NTT DC Reit&rsquo s largest tenant is Tesla. However, NTT DC Reit&rsquo s agreements with its customers contain confidentiality provisions that prevent disclosure of their identities. 

 

Its prospectus said: &ldquo For many of these customers, it is critical that the geographical locations of the data centres in which (their) equipment, information and data are stored are kept confidential in order to minimise the risk of physical threats and intrusions into the relevant data centre.&rdquo  

 

The way I see it, the assumption that NTT DC Reit is heavily exposed to Tesla could haunt it in the months ahead &ndash sending a chill down the spines of investors whenever the electric vehicle maker, or its chief executive Elon Musk, makes headlines for the wrong reasons. 

 

Responding to questions about this risk, the manager of NTT DC Reit said its largest tenant uses its data centres for mission-critical workloads, and has leases extending to 2033 with no termination clause. 

 

The manager added that the tenant is absent from the assets that NTT DC Reit may acquire from the sponsor group over time. &ldquo (Therefore), their concentration will only decrease as the Reit continues to make incremental acquisitions.&rdquo

 

Another factor that might have contributed to NTT DC Reit&rsquo s weak debut is the uncertainty about the direction of long-term global interest rates. Ten-year US Treasury bonds currently yield about 4.42 per cent in 2019, the yield was significantly less than 3 per cent.

 

This is affecting all the Singapore-listed Reits (S-Reits), of course. 

 

The iEdge S-Reit Index chalked up a total return of 54.4 per cent during the five-year period up to end-2019, which trounced the STI&rsquo s total return of 14.9 per cent. 

 

The tables turned, however, as interest rates soared following the pandemic and as companies such as Keppel, Sembcorp Industries and Singtel unlocked value and refocused their businesses. Over the five-year period up to last Friday, the iEdge S-Reit Index returned just 4.6 per cent, while the STI returned 99.3 per cent. 

 

The iEdge S-Reit Index has lagged since the beginning of this year as well, with a total return of 5.2 per cent versus STI&rsquo s total return of 13.4 per cent.

 

While income-oriented investments remain hugely popular with local investors, the most exciting new listings over the next couple of years may well not be in the S-Reit field.

 

Hot data-centre trusts

To be clear, I&rsquo m not suggesting that NTT DC Reit will not recover from its rocky debut. 

 

While higher interest rates since the pandemic have weighed on S-Reits recently, two of the three best-performing components of the iEdge S-Reit Index over the past decade are focused on data centres &ndash namely, KDC (with a total return of 254.4 per cent) and Mapletree Industrial Trust (total return of 133.6 per cent). 

 

It is entirely possible, in my view, that NTT DC Reit will eventually find its feet and perform strongly. Of course, much depends on it achieving or surpassing the forecasts and projections in its prospectus, and acquiring an additional asset or two from its sponsor group on terms accretive to its DPU.

 

There is certainly a lot riding on the success of NTT DC Reit. This is, after all, the most significant new listing in the Republic since the Monetary Authority of Singapore formed the Equities Market Review Group last year. 

 

The measures announced by the review group so far revolve around spurring demand in the local market, and making it easier for companies to list in Singapore. 

 

Perhaps the review group should also look into whether enough is being done to ensure that companies that do list are able to effectively engage with investors, and inclined to quickly address their concerns. 

 

Drawing more new listings to the Singapore market will matter only if they are exciting to local investors, and enhance the vibrancy of the market ecosystem.