Keppel DC REIT Just Announced Its First Acquisition in Japan: Is a REIT an Attractive Investment?

Despite the headwinds facing the REIT sector, several REITs have made opportunistic acquisitions that have allowed them to not only grow their asset base but also improve their distribution per unit (DPU).

One of them is Keppel DC REIT (SGX:AJBU).

The data center REIT announced last week that it had acquired a hyperscale data center in Tokyo, Japan.

The purchase marks the REIT’s first foray into the Land of the Rising Sun, and investors may be wondering about the merits of the move.

Are Keppel DC REIT units an attractive buying opportunity?

Details of the takeover

First, let’s look at the details of Keppel DC REIT’s recent acquisition.

The REIT has agreed with its sponsor, Keppel Sp. z o. o. (SGX:BN4) to acquire the data center for JPY 23.4 billion (or approximately Singapore dollars 201 million).

Keppel DC REIT will own 98.47% of the data centre business, while Keppel Ltd will own the remaining 1.53%.

The purchase was made at a small discount of 2.5% on the property’s valuation of S$206.1 million.

The property is entirely occupied by a Fortune Global 500 company and the land lease is an open-ended agreement.

The data center was built just five years ago, in 2019, and has a weighted average lease expiration (WALE) of approximately seven years.

Management expects the acquisition to be completed by the third quarter of 2024 (3Q2024).

Benefits of the acquisition

The REIT manager highlighted several key benefits of the acquisition.

Japan is the largest and fastest growing data centre market in Asia and the addition of Japan will help further diversify Keppel DC REIT’s geographic exposure.

The country’s data centre market is also forecast to expand at a compound annual growth rate (CAGR) of 10% between 2024 and 2028, with demand expected to remain strong as cloud computing, artificial intelligence (AI) and digital transformation take centre stage.

Another positive factor is that the current data center rent was set in the mid-2010s, which creates an opportunity for a positive rent return with organic rent growth.

Given the tight supply-demand balance in the Greater Tokyo region, the REIT should be able to pass on rising costs to its tenants.

The acquisition will also improve Keppel DC REIT’s operational and financial metrics.

The portfolio occupancy rate will increase from 98.1% to 98.2%, while the portfolio WALE will increase slightly from 6.5 years to 6.6 years.

The REIT will also have a slightly larger share of rental revenue from internet businesses, at 45.1% compared with 44.1% prior to the acquisition.

Most importantly, the REIT’s DPU for 2023 is forecast to increase by 1.1% from S$0.09383 to S$0.09488, assuming the transaction occurs on 1 January 2023.

Because the REIT is taking on Japanese yen-denominated debt as a natural collateral, the average cost of debt will decline from 3.6% to 3.3% following the acquisition.

Swimming with Bluesea

Investors may recall that Keppel DC REIT posted less than optimistic financial results for Q1 2024.

A rent loss from Chinese tenant Bluesea pushed property costs up 89.6% year-on-year to S$12.4 million.

With higher finance costs, DPU for Q1 2024 decreased by 13.7% year-on-year to SGD0.02192.

The manager continues to work with the main tenant of the Guangdong data center REIT and said the tenant is committed to resolving the situation.

For Q1 2024, a payment of RMB 0.65 million was made.

An action plan has been implemented to restore the situation. This is the preferred way to resolve the problem compared to legal proceedings, which would not only be more expensive but also time-consuming.

The board sees signs of recovery but warns that the economic recovery will take some time.

Capital recycling continues

Despite the lack of payments from Bluesea, Keppel DC REIT has undertaken other capital recycling initiatives to unlock value and optimise unitholder returns.

In Q1 2024, the REIT sold Intellicentre Campus in Australia for A$174 million, representing a 148% premium to the original investment of approximately A$70 million.

A portion of the proceeds (A$90 million) were reinvested in an Australian data centre bond issued by Macquarie Data Centres Group, which provides the REIT with a recurring income stream of A$6.3 million per annum at an initial yield of 6.97%.

This series of transactions is expected to increase the REIT’s 2023 DPU by 0.7%.

The manager’s expertise in capital recycling should reassure income investors that the REIT can consistently grow its DPU, excluding the impact of Bluesea.

Be Smart: Sector Fundamentals Remain Strong

Data center market fundamentals remain strong. IndustryARC forecasts the data center sector to grow at a CAGR of 9.6% from 2023 to 2030 to reach $418 billion.

Keppel DC REIT is a direct beneficiary of this growth and should find more opportunities to make better acquisitions.

Combined with good capital recycling capabilities and the negotiation plan with Bluesea, the prospects for Keppel DC REIT look attractive.

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Disclosure: Royston Yang owns shares of Keppel DC REIT.