Data center REITs are also attractive businesses because their services are non-discretionary expenses for companies – the data being stored and processed in data centers is needed to run their operations. As a result, Digital Realty enjoys high utilization rates in most economic environments.
As seen below, Digital Realty’s total portfolio occupancy has remained about 90% in each of the last seven years, including 95% in 2009. The company also notes that its tenant retention ratio has been strong at about 72% of net rentable square footage.
Source: Digital Realty Company Overview
Occupancy and retention rates are also high because it is costly for customers to switch data center facilities. Digital Realty cites that it costs customers anywhere from $10-20 million to migrate to a new facility. A new data center deployment also costs customers $15-30 million, further reducing the incentive to switch landlords. The following chart shows how much higher tenant retention rates have been for data center operators compared to other types of landlords.
Source: Digital Realty Company Overview
Digital Realty’s average remaining lease term with customers is 5.8 years, and fewer than 15% of its total leases are set to expire in any of the next five years. Most of the company’s leases also contain 2-3% annual rental rate increases. As long as customers stay financially healthy to pay their rent obligations, Digital Realty has solid cash flow visibility.
The company is also uniquely positioned to meet the needs of major businesses because of its scale, reputation, and favorable real estate locations in major metropolitan areas. Having customers such as International Business Machines Corp. (NYSE:IBM), Facebook Inc (NASDAQ:FB), LinkedIn Corp (NYSE:LNKD), and Oracle Corporation (NYSE:ORCL) speak to the quality of Digital Realty’s properties.
We also like the company’s diversification by customer (top 20 tenants are 44% of annualized rent) and industry, which helps smooth out earnings. Digital Realty’s mix of data centers is also improving.
In October 2015, the company acquired Telx Holdings for about $1.9 billion. Telx is a leading national provider of data center colocation solutions and doubled Digital Realty’s high-margin colocation business, which allows companies to rent partial spaces within a data center.
Telx also introduced Digital Realty to over 1,000 new companies it can target for its existing data centers. This is important because over 80% of the company’s traditional large footprint leasing activity over the last two years has been repeat business with existing customers.
Overall, Digital Realty operates in an industry with favorable growth trends and gains benefits from its scale, cost-efficient real estate locations, non-discretionary services, and strong customer relationships.
