AS IT approaches its 10th anniversary, Keppel DC Real Estate Investment Trust : AJBU 0% (Reit) has grown its assets under management by almost four times, from S$1.1 billion as at end-2015 to S$3.7 billion as at end-2023.

 

With data centre demand continuing to rise, Loh Hwee Long, chief executive of the Reit&rsquo s manager, said that the Reit will focus on Singapore and Japan for good quality deals that are accretive to its unitholders.

 

He noted that both locations have a tight supply of data centre capacity and high demand, resulting in favourable dynamics for landlords.

 

He also pointed out that the Japanese market is currently experiencing stiff energy constraints, with new developments able to secure power capacity only closer to 2030.

 

Singapore has also taken a cautious approach to providing data centre capacity. In May this year, the government announced that it aimed to provide at least 300 megawatts of additional capacity in the near term. The Republic has 1.4 gigawatts of existing capacity spread across 70 data centres.

 

On the demand side, Loh said that generative artificial intelligence (AI) has also contributed to greater demand as tech giants, such as Microsoft and Amazon, invest more to increase their processing capacities.

 

Expanding to Japan

&ldquo Japan is actually very important geographically as well in terms of global connectivity. The market itself will be increasingly important to serve&hellip as a thoroughfare between the Americas and Asia,&rdquo Loh said.

 

In July, Keppel DC Reit made its first acquisition in Japan &ndash a data centre built in 2019 &ndash for 23.4 billion yen (S$210 million).

 

Loh said that the data centre, which is being leased out to a Fortune 500 hyperscaler (a large cloud services provider) on a shell-and-core basis, is due for a lease renewal in seven years. This compares favourably with other shell-and-core leases that can run for 15 to 20 years with no escalation features in Japan.

 

A shell-and-core lease is a lease of a building&rsquo s basic structure. Definitions vary, but shell-and-core leases typically include power but exclude the technology systems.

 

Because the original lease was signed in the mid-2010s, the rental is at least 15 per cent below current market levels. This gives the Reit &ldquo good certainty and visibility&rdquo of positive rental reversion on the property, said Loh.

 

In Singapore, he noted that Keppel DC Reit tends to acquire data centres that are leased out as colocation facilities, which typically have shorter leases.

 

Four of the Reit&rsquo s six Singapore properties have a weighted average lease expiry by lettable area of less than two years as at Jun 30, 2024.

 

These efforts to drive rental reversions seem to have paid off.

 

For the half year ended Jun 30, the Reit posted an 11.9 per cent year-on-year rise in gross revenue to S$157.2 million

 

However, distribution per unit fell 9.9 per cent to S$0.04549 over the same period, which the Reit manager attributed to a loss allowance for the receivables from its Guangdong data centres.

 

The Reit&rsquo s market capitalisation stood at S$3.6 billion as at Aug 23.

 

Managing China risk

In a Jul 29 report, OCBC analysts noted that &ldquo ongoing concerns&rdquo over the credit profile of Keppel DC Reit&rsquo s master lessee at its Guangdong data centres, following rental arrears, have &ldquo created uncertainties over (its) distributions outlook, and the recovery progress has been sluggish thus far&rdquo .

 

Loh said that the company has made progress in securing interest in the Guangdong data centres from Chinese companies with the help of its master lessee, Bluesea. This amounts to about 12,000 racks of interest, compared with about 8,000 racks of capacity.

 

However, these companies have not been able to take up the capacity, as they intend to use the racks for generative AI purposes and have been unable to secure access to graphics processing units. Such chips are used to train and run AI models.

 

It is only a matter of time before Chinese companies get their hands on them, Loh said, even as US sanctions prevent the best of these chips from being exported to China.

 

&ldquo From the Chinese side, you&rsquo ve got players like Huawei that are also making quite a fair bit of breakthroughs so, hopefully, from a supply chain perspective, they catch up quickly enough,&rdquo he added.

 

He also said that Keppel DC Reit will favour going into deals that involve single, larger tenants instead of master lessees with many small tenants.

 

In China, Loh said that the government clampdown on sectors such as cryptocurrency and gaming has hurt smaller enterprises which had taken on subleases with Bluesea. With these smaller players unable to continue, the underlying tenancy is broken.

 

He said: &ldquo We&rsquo re also trying to look into deals, like what we did in Japan, where we deal directly with the hyperscalers.

 

&ldquo In that sense, it derisks the deal a lot more.&rdquo

It raises its DPU forecast for the trust by 4 per cent, amid rising demand for colocation space

BROKERAGE firm UOB Kay Hian (UOBKH) has upgraded its call on Keppel DC Real Estate Investment Trust (Reit) to &ldquo buy&rdquo from &ldquo hold&rdquo , and raised its target price to S$2.09, from S$1.98. 

 

This comes after the trust surpassed the firm&rsquo s expectations for the first half, with a positive rental reversion of more than 40 per cent for a major renewal contract in Singapore in Q2 FY2024. 

 

Positive rental reversions are expected to continue in the second half of the year, as the trust continues to benefit from strong demand and a tight vacancy rate of 1 per cent in Singapore. 

 

Revenue contribution from Singapore grew 6.6 per cent year on year in H1 FY2024, amid a slight easing in portfolio occupancy &ndash which inched down 0.8 percentage point to 97.5 per cent in the second quarter of FY2024. 

 

UOBKH expects a similar positive rental reversion for the Reit&rsquo s expansion into Japan. The trust holds about a 98.5 per cent effective interest rate in the Tokyo Data Centre 1. 

 

It is leased to a Fortune Global 500 company which is an existing top 10 tenant, on a triple-net basis with a remaining lease term of seven years. 

 

The existing passing rent in place is 10 to 15 per cent below the market rate, suggesting positive rental reversion when the lease is renewed seven years later.

 

The acquisition, which is accretive to distributions per unit (DPU) by 1.1 per cent, is projected to be completed in Q3 FY2024. 

 

The research team also raised its DPU forecast by 4 per cent, citing strong positive rental reversions for colocation data centres in Singapore. This comes as demand for colocation space arising from artificial intelligence-powered applications persists. 

Additionally, provisions for the Reit&rsquo s Guangdong data centres are expected to persist in the second half this year and into FY2025. 

 

Analyst Jonathan Koh noted, however, that the managers of the trust were making progress on a recovery road map for the Chinese data centres, which includes building a leasing pipeline. 

 

It plans to submit proposals to potential tenants, such as artificial intelligence startups, Koh added. 

 

A potential interest rate cut by the European Central Bank could also benefit the Reit. Its euro-dominated debt accounted for 40 per cent of total borrowings. 

 

About 7 per cent of total borrowings maturing in 2025 are denominated in euros, and on floating interest rates that are not hedged. 

 

Koh said he expects the trust to continue scouting for opportunities to acquire data centres in its preferred markets of Singapore and Japan, as AI continues to fuel the demand for these facilities.

 

Keppel DC REIT has reported a distribution per unit (DPU) of 4.549 cents for the 1HFY2024 ended June 30, a 9.9% y-o-y decrease from 5.051 cents the same period a year before, but a 5% h-o-h increase from 4.332 cents in 2HFY2023. 

 

The REIT recorded a distributable income of $80.9 million, a 11.4% y-o-y decrease from $91.3 million, but a 5.9% h-o-h increase from $76.4 million. 

 

Gross revenue rose 11.9% y-o-y to $157.2 million in the first half 2024, compared to $140.5 million in the same period a year before, and the REIT recorded a 4.2% higher y-o-y net property income of $132.6 million compared to $127.4 million in the same period a year before. 

 

The REIT attributes this y-o-y lower DPU to loss allowance for the Guangdong DCs, higher finance costs and depreciation of foreign currencies against the SGD. This was partially offset by increase in rents from strong positive reversions and escalations as well as higher variable rent arising from the DXC settlement sum received, they say. 

 

DXC paid a settlement amount of $13.3 million by April 2024, as a &ldquo commercial and amicable resolution&rdquo to the payment dispute, which involved the partial default of payment related to the provision of colocation services of a data centre in Serangoon North. 

 

Meanwhile, Keppel DC REIT says that its h-o-h performance which saw an increase in DPU is due to a positive reversion of more than 40% for a major contract renewal in Singapore as part of the Keppel leases.

 

It says its higher gross revenue h-o-h is mainly due to healthy positive reversions and escalations across portfolio as well as higher variable rent arising from the settlement sum received relating to the dispute with DXC Guangdong DCs 1HFY2024 income net off via loss

allowance. 

 

As at June 30, the REIT&rsquo s portfolio occupancy stood at 97.5% while its weighted average lease expiry (WALE) stood at 6.4 years by lettable area.

 

The REIT says that as at June, its aggregate leverage stood at 35.8%   mainly due to repayment of about $58.5 million debt for Intellicentre Campus and other EUR-denominated debt to strengthen the balance sheet for growth.

 

Post-acquisition of Tokyo Data Centre 1, aggregate leverage expected to be 39.2% with a lower average cost of debt of about 3.3% as at June 30 on a pro forma basis.

 

Unitholders will receive their distributions on Sept 23. 

 

Keppel DC REIT says that the strong momentum of investments into data centres is expected to continue this year fuelled by institutional investments and strong underlying fundamentals.

 

&ldquo The reliance on data centre facilities and digital infrastructure for business, commerce and communication continues to grow on the back of demand to power new-age technologies such as generative artificial intelligence, streaming services, digital applications, Internet of Things and e-commerce platforms,&rdquo it notes in a release dated July 26. 

 

Keppel DC REIT is well-positioned to capitalise on the robust growth of the data centre industry, says the REIT. &ldquo Overall, the operating performance of Keppel DC REIT&rsquo s portfolio is expected to remain strong, underpinned by high occupancy and positive reversions. Looking ahead, the manager remains focused on enhancing its portfolio through strategic acquisitions, portfolio optimisation and proactive asset management, ensuring sustainable value creation for its stakeholders,&rdquo it ends. 

 

The manager of Keppel DC REIT has entered into an agreement to acquire a shell and core data centre located in Tokyo, Japan for JPY23.4 billion ($201 million).

 

The total purchase consideration represents a 2.5% discount to the property&rsquo s valuation of JPY24 billion. 

 

Keppel DC REIT will have a 98.47% effective interest in the property, while the remaining 1.53% effective interest in the property will be held by Keppel.

 

The freehold multi-storey property Tokyo Data Centre 1 was completed in 2019 with a net lettable area of 190,166 sqft. Located in West Tokyo, Tokyo Data Centre 1 is part of a primary data centre hub. It is built to the latest seismic design standards with a base isolation system.

 

It is master leased on a triple-net basis to a Fortune Global 500 company and hyperscaler. With the remaining lease term of approximately seven years, there is an opportunity for positive rental reversion and potential for further organic growth on the back of growing demand for generative artificial intelligence (AI) and tight data centre supply in Japan, the manager notes in a filing.

 

The acquisition marks Keppel DC REIT&rsquo s maiden entry into Japan, the second largest data centre hub in Asia, projected to expand at a compounded annual growth rate of over 10% from 2024 to 2028. 

 

Tokyo has an estimated operational IT load of more than 1,000 megawatts (MW), which makes up over 80% of the total operational capacity in Japan.

 

&ldquo Japan is a core market and the addition of Tokyo Data Centre 1 will further strengthen our portfolio&rsquo s geographical, as well as income diversification,&rdquo says CEO of the manager Loh Hwee Long.

 

The inclusion of Tokyo Data Centre 1 will enhance Keppel DC REIT&rsquo s portfolio occupancy from 98.1% to 98.2% and increase the weighted average lease expiry (WALE) by lettable area from 6.5 years to 6.6 years. 

 

The acquisition of Tokyo Data Centre 1 is estimated to be completed in 3Q2024. Keppel DC REIT&rsquo s assets under management will increase to $3.8 billion with a total of 23 data centres across 10 countries in Asia Pacific and Europe.

 

The acquisition is expected to be 1.1% accretive to distribution per unit (DPU).

 

Tokyo Data Centre 1 is expected to be funded through yen-denominated debt, providing natural hedge over its capital value. As yen-denominated loans are lower in costs, this is expected to bring down the costs of financing. 

 

Upon completion of the acquisition, Keppel DC REIT&rsquo s average cost of debt will improve to 3.3% with an aggregate leverage of 39.4%.