Not US, but EU
Share price has corrected more than 36% since the start of the year
Concerns on rising interest rates. With interest rates beginning its upward trend since the start of FY22F, concerns were raised on its impact to DCREIT’s earnings, especially as the REIT’s entire loan book was on floating rates. DCREIT subsequently worked on hedging 50% of its loan book and reported a doubling of its all-in financing cost to 2.1% in 1Q22. During the quarter, we also understand that some of the increase in financing costs were mitigated from savings in certain trust expenses and lower profit attributable to non-controlling interests. These savings were estimated to be c.US$1.5m, or half the impact of the increase in financing costs.
Factoring in rising financing costs. With interest rates expected to rise further, this will continue to pose a risk to DCREIT’s earnings. We have taken this into account in our revised projections and assumed higher all-in borrowing costs going forward. Our revised estimates assume that DCREIT’s all-in borrowing costs in FY22 will be 2.8%, and we factored in a further 20bps increase to 3.0% from FY23 onwards. Our estimates were derived from assumptions that USD loan costs will average c.3.0%, while any loans denominated in EUR will cost c.2.0%. We have also assumed that interest rates could potentially inch up by another 20bps in FY23.
First acquisition taking longer than expected but we expect it to happen sooner rather than later
First acquisition expected to be in Europe rather than the US. Despite taking longer than anticipated to embark on its first acquisition, we remain confident that DCREIT will deliver an acquisition within 3Q22. With higher financing costs eroding margins and cap rate spreads (spread between cap rates and interest rates) turning negative in several markets, we think that there is an even more pressing need for an acquisition to happen sooner rather than later. Within the markets where DCREIT’s sponsor pipeline is concentrated, we see acquisitions in Europe and Japan as the most likely in the near term.
DCREIT has previously highlighted its intentions to expand in the US, but with cap rate spreads now in the negative territory, we believe that any acquisitions will be unlikely or will have to be bundled into a portfolio with assets outside of the US, which still provides a positive spread.
Only focused on acquisitions in FY22F. In our revised estimates, we continue to maintain our assumptions of US$250m in acquisitions in FY22F. Looking further ahead, we believe that acquisitions beyond the next six months could be more uncertain as interest rates continue to inch up, while cap rates for data centres continue to remain at record low levels. As such, we decided to adopt a prudent approach in our growth expectations for DCREIT and removed all acquisition assumptions beyond FY22. Previously, we had assumed up to US$500m in acquisitions in FY23, given the conducive environment for acquisitions and fund-raising.
In our revised estimates, we have also rolled back our assumption for the acquisitions to only contribute one quarter of earnings. For this US$250m in acquisitions in FY22F, we will still be maintaining the assumption that it will be a fully debt-funded acquisition, given DCREIT’s ample debt headroom. We will also be maintaining our assumed NPI yield of 4.5% for acquisitions this year.
Sensitivity of acquisition yield on DPU accretion. Although we have maintained our assumed NPI yield for acquisitions this year to be 4.5%, there could be a possibility of slightly higher yields for acquisitions carried out in Europe. Conversely, we also considered the possibility of lower NPI yields in our sensitivity study. In general, we believe debt-funded acquisitions in FY22 would be accretive, as there are still positive cap rate spreads for data centres in several markets, specifically in Europe. Accretion to DPU in FY22F will be muted as we have only assumed the acquisitions to contribute only one quarter, and the full-year accretion to DPU will only be reflected in FY23F and beyond.
Acquisition backed by EFR will still be accretive. Another possibility to fund the assumed US$250m in acquisitions in FY22F could be through a mix of debt and equity. In this exercise, we have assumed that DCREIT relies on a debt and equity mix of 60:40. Based on our worst-case scenario assumptions of an EFR (equity fund raising) at US$0.70 and an acquisition yield of 4.0%, acquisitions done in FY22F would still be c.0.4% accretive to DPU. However, we see this as highly unlikely for its maiden acquisition, especially given DCREIT’s current trading price (more than 16% discount to NAV). We believe that DCREIT would not want to risk destroying investor confidence by raising equity at a significant discount to NAV, even though it may still prove to be accretive to DPU.