My investments into Keppel DC REIT have been a horrendous experience thus far. I am currently looking at an unrealised loss of <12.79%> after the recent deep dive in market valuation. The other pure Data Centre REIT- Digital Core REIT ("DCREIT")- fares no better at its current poignant valuation of US$0.76 per unit as at 4 July 2022 and depending on your timing of purchase, one could be starring at as much as a whopping <36.7%> plunge in valuation if you have purchased it on 17 Jan 2022 at US$1.20 per unit. If you have subscribed for DCREIT during its maiden IPO and is successful in your allotment at US$0.88 per unit, then you will still be staring at a loss of <13.6%>. Given the terrible performance and worsening market sentiment, is it the time to throw in the towel and dispose of one's holdings rather than holding on to them? What exactly happen to have caused such a terrible crash in market prices for data centres?
Since the beginning of Jan 2022, Keppel DC REIT has been plummeting non-stop from S$2.47 per unit to as low as S$1.90 per unit in 16th June 2022 which is a jaw dropping decline of <23%>. The main reason that everyone is aware of is the rising borrowing rates by the US Federal Reserve in its fight against inflation. However, during this same time frame, DCREIT remained in superman mode and performed a gravity defying stance that hovers above the US$1 mark per unit for the bulk of this period. There are actually another 2 developments that crop up recently which leads to the demystifying of the invincibility and relatively safe protection offered by data centre REITs. Suddenly, data centre REITs are no longer as safe as investors thought it to be. Let me further elaborate on the below:
1. Bankruptcy of major tenant of DCREIT
Despite all the hoo-ha on the extremely long WALE of data centre REITs relative to other REIT sectors, the fact of the day is that fundamental and quality of one's tenant is of paramount importance. Even if the WALE is for 5-6 years, if any tenant goes bankrupt, the REIT will not get paid eventually. The shocking bankruptcy of DCREIT's 5th major tenant is a good example. Data Centre REITs are definitely not the same as government bonds as being asserted by some retail investors.
2. Industry outlook for data centres severely affected recently by shock revelations of skeptics that "hyperscalers" (Google Cloud, Microsoft Azure and Amazon Web Services) are building up their own data centres to their own design rather than moving into existing ones.
Investment advisor and financier Jim Chanos has taken large short positions against data centres REITs and betting that the trio hyperscalers cloud providers (Google Cloud, Microsoft Azure and Amazon Web Services) will takeover their businesses. Ever since Jim's remarks on 29th June 2022, DCREIT price has crashed below US$0.80 per unit. Hence I think that many institutional and retail investors are now extremely worried about the future of their investments into data centre focused REITs and wondering whether the historical compressed yield of 4%-5% is viable in view of the risk profile changes in recent industrial development.
Cloud computing is definitely growing but much of the value accruing is to the current 3 big boys of Alphabet, Microsoft and Amazon. Hence, the dynamic trio are actually not the data centre REITs biggest customers but more of their biggest competitors. The deep pocket of the trio make them vicious rivals in the data centre business as they embark on aggressive building up of their own data centre infrastructure. The role of 3rd party data centres is more of to support the growth of the trio hyperscalers when they could not build fast enough and then turn to data centres firms to develop sites or to lease wholesale space.
Chanos further argued that as the trio hyperscalers grow more powerful, the margins they offer will grow even lower. REITs thus suffered from technical obsolescence and will soon be in a period of declining revenue and growth.
It seems that the domination of data centre REITs like Digital Realty, Equinix and Keppel DC REIT is coming to an end in the mid to long term. Who could have anticipated the possibility of such a development 2-3 years ago when data centres are all the rage then? Despite the significant decline in market pricing for DCREIT, I do not plan to acquire any units in DCREIT (unless it drops to below US$0.70 per unit for a 6% distribution yield to compensate for sufficient margin of safety) and will be keeping my investments in data centres to Keppel DC REIT, Ascendas REIT and Mapletree Industrial Trust backed by their well-heeled ultimate sponsor in Temasek Holdings.
(Note: There is also a problem with some retail investors who are over-confident in their views that one must always decide whether something is black or white/ Yes or No. The hard truth is that no one knows exactly when a spanner will be thrown into the works like the above latest development. Hence having a liberal mind on discussion of 2 sides of a coin should never be perceived to be "filmsy" or "airy". Neither should one be overly confrontational with aggressive "challenges" on others who writes about possibilities of different perspectives and things going either way.)