Welcome to Citi's 2024 Global Property CEO Conference. My name is Andy from the banking team, and we're pleased to have John Stewart from Digital Core REIT, Hwee Long from Keppel DC REIT. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and the AV desk. For those in the room or the webcast, you can go to liveqa.com and enter code GPC24 to submit any questions if you do not want to, to raise your hand. John and Hwee Long, I will turn it over to you individually to introduce your company and the team, provide any opening remarks, tell the audience the top reasons why they should invest in your company, and then we can turn it over to Q&A.
John, maybe I'll start with you to have your opening remarks.
Great. Thanks, Andy. Thanks for having us, and thank you all for joining us and your interest in Asia data center s. So my name's John Stewart. I'm CEO of Digital Core REIT. We are sponsored by Digital Realty. We own a portfolio of 10 assets, predominantly in North America, but we've also expanded into Frankfurt and Japan. In terms of the reasons I would recommend you should invest in our stock today, I'd say, first of all, we have an under-levered balance sheet today, so plenty of capacity to invest, and we're trading at a healthy double-digit discount to NAV. You know, we-- I think we are-- we're both very fortunate that we're operating in a sector, and we're benefiting from tremendous demand tailwind.
Really, a disconnect between fundamentals and valuation presents, I think, an intriguing opportunity to invest in the sector.
Hwee Long?
Okay. Thank you. Thank you, Andy. Good afternoon, everybody. My name is Hwee Long. I'm the CEO for Keppel DC REIT. That's, of course, I think listed in Singapore. So for us, we are a REIT that is sponsored by a company called Keppel Limited, right? Which is a multi-sector company that is investing, you know, has a focus in three main verticals: real estate, infrastructure, as well as connectivity, where the data center business resides. So for the Keppel DC REIT, today we own a portfolio of about 23 data center assets across both Asia Pacific as well as the European markets.
Out of these 23 data center, I think from a portfolio composition perspective, we are probably around 70, 70%, right, across the Asia Pac, with a very strong anchor, right, in Singapore market. So Singapore market alone takes up more than 50% of our entire portfolio, right? The remaining 20-over % are assets that are threaded across the core European markets. They call it the FLAPD markets, so Frankfurt, London, Amsterdam, Dublin, as well as in Milan, in Italy, right? In terms of, I think, you know, key reasons why you would want to take a closer look at our counter, right?
One part, I think, as the name of the panel suggests, right, if you are looking for, Asia exposure, Asia Pacific exposure, especially, you know, to take part in the exponential growth, right, in the DC space, for Asia, we are probably one of the, REIT that you should, consider quite seriously, right? Especially given our, exposure as well as, I think, the strength of the sponsor, right, when it comes to the Asia Pacific region in terms of creating, new data center products that can ultimately form, you know, part of the so-called sponsor pipeline that we can consider apart from third-party deals. Yeah.
And, more importantly, of course, I think, given how I think the sector is developing, right, I think globally, power become increasingly, you know, issue, right, in terms of constraints, right? So having a sponsor like Keppel Limited, where we also have capabilities in the energy side of things, you know, renewable energy, that can bring forth, I think, quite interesting opportunities in terms of unlocking, I think, future data center type of product types. Yep. Thank you.
Hwee Long, maybe we stay with you. I think when we think about the, you know, strong demand trajectory of, you know, data center demand, AI in the cloud, if you can kind of walk through... I know you have quite a few assets across different geographies. If you can just talk about, you know, the rent prospects for, you know, APAC, Europe, per se, and you know, where you see rent rates going for your portfolio.
Okay, thank you. So I think, broadly, I think in terms of, from a data center perspective, obviously, I think demand has been, fairly robust. We are sitting on a very strong tailwind. And, I think in the recent, you know, past, you know, especially in the past 12, 18 months, you do read a lot about, you know, the potential demand that is, gonna be generated due to, this AI-driven, you know, type of, workloads, right? So I think we are living in such a, backdrop, a global backdrop in that sense. So, definitely, I think from an APAC perspective, you know, we will also, you know, be there to ride on this tailwind in a sense, right?
If you look at our portfolio itself today, right, across APAC, I think in terms of where we are, you know, where we are in, obviously, like I mentioned earlier on, Singapore is a very strong anchor type of market that we have our presence in, right? Apart from that, we are also in places like Australia, Malaysia. We also have a more recently, you know, started to go into China. And then in the European side, of course, I think the key FLAPD markets. But if you look at it, most of our assets actually, you know, they're either a combination of master lease, net assets, net lease assets, or in terms of colocation, we are quite focused, right?
They are largely concentrated in markets like Singapore as well as Dublin. And these two markets, if you look at it globally today, right, common thematic, they are all supply constraint, right? Because of, moratoriums that were put in place, right, in these two, markets. So as a result, I think there's a natural, impediment to new supply, you know, going into the market. But at the same time, right, because of, things like generative AI, right, demand continue to grow. So I think in these markets, I think we are relatively lucky in that sense, that we are-- we continue to see very robust, rental, you know, reversion type of, situation, right, due to that, demand-supply, imbalance.
J ohn?
Yeah, I think he hit the nail on the head, quite frankly. I was going to circle back to make the supply point, but I think he effectively addressed that. As a result, you know, it's a relatively unique point in the cycle for data centers. I'd say you probably have the healthiest fundamentals that we've had in years and better pricing power. What's also interesting is it's really on-- I mean, every market is unique, but it's sort of a global basis, and you can point to different reasons in different markets. In the U.S., you've got a couple of instances where the utility provider is unable to deliver new supply.
So, you know, slightly different from the reasons in Singapore and Dublin, but the same effect that you have effectively constrained supply at the same time that you've got very strong demand, obviously resulting in very healthy pricing and, like I said, you know, the best fundamentals that we've enjoyed in quite some time.
I think we touched a bit about, I guess, AI. You know, I think one thing on investors' mind is kind of the, I guess, relevance of the portfolio or rather specifically, any opportunities within the portfolio that can be, say, converted into AI-enabled assets. So John, maybe on your portfolio, any interesting redevelopment opportunities or that you're seeing in your portfolio?
Sure. A couple of redevelopment opportunities, although not, I wouldn't say AI related. AI is a rising tide that's lifting all ships. And, you know, the AI requirements are more power intensive and require greater cooling. But most data centers. It's, you know, it's at the end of the day, it's an engineering problem that can be solved. Now, to be clear, some of the very largest, like AI startup, large language models, you know, those specific applications may be going to a brand-new state-of-the-art purpose-built facility that is more power dense and, you know, maybe using liquid cooling to the rack or to the chip. So that, you know, that's one application.
However, I can tell you that, you know, even you know, a couple of the oldest assets in our portfolio are NVIDIA DGX certified, are water-cooled, and with that infrastructure in place, we have the ability to provide a liquid cool. We can deliver water to the rack or to the chip, and we're running AI applications in those assets today. They do tend to be what we call hotspots, right? So, you know, there is a you know, marquee AI name operating a cage within one of our assets in L.A., that is much more power intensive and requires greater cooling. But, that's. The entire facility is not set up to accommodate that, but we're seeing hotspots for AI, you know, inferencing, for instance, smaller workloads within our existing facilities.
And again, from our perspective, we don't need to redevelop the portfolio to accommodate those deployments.
Okay. I think I do share John's view as well. I think similarly for our portfolio, I think we still see a similar characteristic, right? In fact, I think if you look at in this whole AI grand scheme of things, right, while you know there are obviously the new so-called state-of-the-art type of new facilities that are tailor-made or tailor-designed, right, to undertake the so-called large language models type of machine learning type of AI workload.
I think we also should not also forget that actually in the AI spectrum, the entire service delivery itself, right, there's also still a need for traditional cloud type of requirements in order to roll out the, you know, the outcome, the outputs of all these AI data sets, right? And these will be more latency sensitive type of workloads that will still be, you know, require the traditional, more urbanized type of data center to service. And actually, quite interestingly, I recently also read a article, right, that came out. You know, we know about cloud computing. There is this new term that I just learned called fog computing , right?
Effectively, it's. What it means is that, while generative AI creates new opportunities, right, in terms of new builds to cater to the machine learning type of facilities that has all these new cooling technologies, you still do require, in fact, as the generative AI workload increases, there's also continual increase in the, what you call, demand, right? For the whether is it traditional cloud-based type of data centers or such edge DCs that basically has a much more stringent latency requirements to do that so-called last mile delivery type of a service deployment. Yeah.
Yeah, that's exactly right. I mean, AI is incremental, right? It's not gonna replace all the existing workloads that are deployed. You, you know, think about Microsoft Copilot, right? That's gonna be on top of your, your Outlook and your Teams, right? It's not, it's not gonna replace them.
Yeah, I agree with that. Yeah.
Yeah. Maybe just more on the customer side, 'cause I think the backdrop seems rosy. Demand is good. I think, John, on your side, I think that the issue around Cyxtera, it's probably more, I mean, resolved. But just going forward on your portfolio, how do you think about the customer quality?
Sure.
And then I will turn it over to Hwee Long to talk about, I think, what's happening in China as well. But maybe, John, we'll start with you.
Sure.
Yeah.
Yeah. We did have a couple of customer bankruptcies. I think from our perspective, it was really. The challenge was concentration. They were very large percentages of our rent roll, and that really is what caused the problem in the first place, was that we were too concentrated. The both of those customers happened to be they were colocation resellers. You know, a little bit of the WeWork model of the data center business, right? Where you didn't own the real estate, and so not necessarily in control of your own destiny.
Then when you have an environment where interest rates are going up, and at the same time you've got an energy spike and a business model that doesn't necessarily allow you to pass through those costs to the end users, that obviously sets up a difficult environment. But from our perspective, you know, following the resolution of those two customer bankruptcies, 90% of our rent roll is double A or better. So, fortunately, you know, I don't think there's another shoe to drop. And we're looking forward to creating value and repositioning the assets that we got back and feel very good about the road going forward.
Okay. I think for the case of, Keppel DC REIT, I think to your point, I think, on the Chinese situation, I think today, of course, when you flip open the, newspapers, I think the environment in China is not the most conducive. You know, it's, actually facing quite a fair bit of headwinds. So, I think it's really against that backdrop that I think the, you know, our data center is set in the Guangdong. I think similarly, our master tenant is, facing some headwinds from that perspective. And also, I think historically, for the past, one, two years, you also do see, I think from a Chinese, regulatory perspective, the government has been tightening quite a fair bit of, controls, right, surrounding sectors such as, what is it called?
Cryptocurrencies, the gaming sectors, the even online tuitions type of sectors. And all these do have a very strong bearings, right, on the... particularly, I think, the retail enterprise and of the DC demand itself. So for this particular, I think, data center asset that we own in Guangdong, right, I think the master tenancy, the master tenant, sorry, is the underlying tenancy, you know, behind the master tenant is really more catered towards the retail enterprise side of the business. And, you know, that in itself, I think, took a beating. I think given the current challenges, I think that the that the country is facing right now, right?
But notwithstanding that, I think what we have done is really, I think we have a recovery arrangement that has been discussed and agreed upon, right, with the master tenant. So now we are going through the execution of that plan, and hopefully, you know, together, I think we can get to a better landing, right, in the, in time to come. Talking about the point in terms of the tenancy, right? If you look at our portfolio, right, notwithstanding the China situation, actually, our focus, Keppel as a group in basically, I think our focus has been, you know, more on the hyperscale end of the, of the segment.
So all the global, right, large hyperscalers, whether is it from the Americas or from the Chinese side, they are probably one of our existing customers, right? And from to John's point, I think in terms of the colo reseller type of exposure, I think today within our portfolio, we have a smaller percentage of that. That makes up a very small percentage of it. So I think our approach moving forward is really to focus, right? To be very focused and stay close, right, to the hyperscaler segment, right, in terms of how we look at and also rethink our portfolio composition, right?
I mean, you just have to look at, I think, how the hyperscalers in terms of their businesses, you know, their results earning season have been, I think, fairly strong and resilient, I think, in the past, you know. And especially now, given generative AI, I think it should continue on, I think, moving in the foreseeable future. Yeah.
I think we talked about rent and demand, but, I think we think about the expense side, you know, utility cost is higher. You know, there's definitely inflationary pressure as well. Maybe, Hwee Long, starting with you, just in terms of the way you think about your portfolio, you know, NPM margin, you know, how do you see that going into the, you know, 2024? Any pressure points that you're seeing in terms of specific expenses as well?
Thank you. Yeah, you're absolutely right. I think the single biggest, or rather one of the largest, line item when it comes to OpEx is really, I think, on the utility side, energy prices. And, certainly, I think, you know, given the global hotspots, when it comes to conflicts, right, that caused the energy, you know, prices to really go up to, you know, unprecedented levels. Now, that also caused us to rethink in terms of how we look at our portfolio, in terms of how we structure our leases, right? So today, I think if you look at our assets, of course, I think we have a huge component, of which are master lease assets on triple net basis.
So in those instances, quite straightforward, the tenants are already responsible for energy prices, right? But where we have, right, the colocation assets, which are peppered around Singapore, and Ireland, in Dublin, right? What the team has done is really over the course of the past 18-24 months, right, we have taken the opportunities whenever leases come up for renewal, to relook into, right, restructuring those leases such that it become on a pass-through type of arrangement, right? And on that basis, I think as we speak today, right, out of those colocation leases, I think we are happy to report that we have a pretty high percentage of leases that are restructured into that pass-through arrangement. Today, it's about 93%-94% of our leases are structured this way.
J ohn?
Yeah, so for us, we'd had a hundred percent of our leases were passed through, so utilities is not not so much an issue for us. However, I'd say we are seeing pressure on labor costs and property taxes. Both of those are they're facing inflationary pressures, for sure. And so in terms of the impact on margin, you know, we're definitely doing our best to protect, and I think the biggest opportunity for expansion is ultimately, you know, just lease up and driving additional occupancy is really the best offset.
Okay. Maybe we should pivot into something a bit more exciting and forward-looking. John, I'll start with you in terms of, I guess, acquisitions. You know, since IPO, 100%, I would say North America, but, you know, over the last two years, Frankfurt, and then recently Osaka. You know, how should we think about your geography expansion in 2024? Are you looking more at sponsor pipeline, or are there third-party acquisitions you're looking at? If you can talk about that, then Hwee Long, we'll pivot back to you.
Sure. Yeah, I'd say we're certainly open to both acquisitions from the sponsor pipeline as well as third parties. And we definitely are focused on geographic diversification, so look to continue to expand. Both of the assets that you mentioned, Andy, the asset in Frankfurt and Osaka, we acquired minority stakes, so we can continue to increase our and plan to continue to increase our ownership interests in both of those assets. And that's kind of the nearest term, most actionable roadmap. We'll certainly look to continue to expand beyond those, but those are both pretty. You know, one of the facts about data centers is they tend to be pretty site capital intensive and large ticket acquisitions.
So there's, you know, ample room to continue to invest in, in both of those—they're both $550 million assets, which is a pretty good, pretty, pretty good slug for us, so we can continue to take down chunks of those one at a time, and we'll continue to look to diversify. I'd say we are definitely focused on expanding our presence in Asia. We're—unfortunately, we're not, blessed with the, the portfolio in, in Singapore that, that my compatriot is. But, we'll, we'll certainly look to expand, quite frankly, in, in all three regions, and in particular, look to expand in APAC.
Hwee Long?
Okay, yeah. I think from a perspective of Keppel DC, taking a step back, of course, I think we are structured as a REIT, right? So as a result of... That's why we are more focused, I think, on the, you know, stabilized type of data center asset class, right? And in a world also, because we are listed REIT, so we are definitely a lot more sensitive to, you know, interest rate type of environment, which, I think today, globally, right? If you look at global markets, a lot of markets, interest rate are still wow. You know, we see some light at the end of tunnel, right? That of it tapering off, right? At this moment, it's still at pretty high levels, right?
Which makes it, to be honest, fairly challenging in a lot of markets to do accretive deals, right? Especially because of the sheer amount of competition, right, in the data center space itself, which means that while we do see a bit of correction in some of the other commercial real estate classes, unfortunately, right, I think in the DC space, right, cap rates have not really expanded much, right? And in most instances, they are either, you know, holding firm, and in fact, in certain markets, they're actually tightening, right?
So I think against that backdrop, in terms of the you know, geographically, the number of markets that we can you know, be a lot more bullish on, it kind of dwindled down the number of markets that we can look at. But now extending that, I think given you know, you know, the the Fed, it seems to be signaling quite strongly that towards the second half of this year, we should start to see you know, interest rate tapering off, right? Hopefully, that opens up a new window, and we'll certainly be keen to you know, take advantage of any such openings.
But, now extending that, of course, I think today, right, globally, there are still, you know, quite a lot of markets where the yield spread between the top transaction cap rates versus interest rates still make a lot of sense. I think, John, also, I think they have done very well, right, in places like Japan, right? Where we can still take advantage of the pretty low, right, interest rate that still has a pretty healthy spread against the transactional cap rate. So these markets will be, you know, more interesting at this moment, right, to do good quality deals. And for us as well, I think back home in Singapore, right? Singapore is also another pretty unique market, while the demand-supply fundamentals are very, very strong, right?
But from a transaction perspective, right, if deals come about, you know, generally, we can still expect a, a decent, I think, spread across, compared to the cost of borrowings. So I think where the right deals comes about, you know, definitely we will, we will be very keen to, add on, right, to our portfolio.
Yeah. Maybe we should spend a bit of time on valuations and, I think Hwee Long did mention, you know, certain geographies tightening, and I think that's true for, you know, maybe Japan and stuff. But I think, John, you know, on your portfolio, there was some devaluation that happened, especially on the U.S. assets. So maybe from your perspective, you know, where do you see valuations going for data centers? Not specifically for U.S., but just generally across, I guess, globally as well. It'd be good to get your perspective.
Sure. Yeah. I mean, I think one thing that's maybe a little unique to our portfolio is that we are more indexed towards North America. And, you know, obviously, I think North America led the charge in terms of the move higher in interest rates. And so, yeah, we did see a little bit of cap rate expansion. But also factored into that was the fact that we had a customer bankruptcy, right? So the biggest hits that we took were the assets that were impacted by the customer bankruptcies. So that kinda colored the glass a little bit. So we in total wrote... or we took a 9% write-down at year-end when our assets were revalued.
Going forward, however, I would say, for a couple of reasons, I think, you know, interest rates have hopefully we'll see an easing off in the second half. But at a minimum, they seem to have stabilized, right? And so investors can basically underwrite a terminal exit rate. And there's, you know, everybody's kinda made it, right? We've survived to here, and so I think you're not seeing distress. At the same time, we've been very blessed by AI, right? That's just... It's obvious the demand that that has driven, and investors are looking for derivative ways to play infrastructure specifically.
And so to get to the point, I think, quite frankly, that we will. I don't know that we've seen tightening yet in our markets, but I think we will. I think cap rates will head lower in 2024, not higher.
Yeah. Well, maybe just on, on your portfolio specifically, 'cause I mean, that Singapore, you talked about, you know, the moratorium, and it's an interesting market. You know, where do you see cap rates, you know, going in, in Singapore?
Yeah. I think, okay, pertaining to Singapore, right, certainly I think we do, I, I do hope, right, it to continue to be, you know, relatively stable in that sense. But, to your—to John's point as well, I think given how things are transpiring, right, we probably should be anticipating some level of compression in that sense. But if you look at our portfolio overall, I mean, for the, for the, you know, for the past one year, if you look at our valuation, I think we managed to hold it fairly firm, right? In fact, I think if you look at it on the local currency perspective, and we managed to actually generally increase, right? Or not increase, sorry, improve our valuation, which means, slightly, you know, tightening on the cap rates.
But the thing is, because we are, you know, S-REIT, so we are SGD denominated, so there are some translation, currency translation issues when you come back to Singapore. So on a net basis, the whole portfolio is basically, you know, stable, held stable, held firm in terms of year-on-year change in the valuation. But I think if you look at it on a forward basis, yeah, I do share John's view. I think, you know, given where how the sector is developing and especially with some of these new, you know, macro trends that are anchoring, I think the forward development of the industry, yeah, we... I do expect some form of tightening to happen. Yeah.
And we can just pivot a bit to, I guess, capital structure. I think we'll start with you, Hwee Long. Just in terms of, you know, where you, you know, have your latest debt cost, I think that increased quite a bit, you know, vis-a-vis two to three years ago. If you look forward to 2024, where do you think your debt cost will settle, and, do you think that will be kind of where, you know, there'll be a stabilized funding cost going forward, et cetera? We can pivot back to John.
Yeah. Okay, I think if you look at our debt cost today, we are probably hovering in the mid-3%, right, on a blended basis for the whole portfolio. And, actually, if you look back, this has already come up quite substantially compared to where we were historically. That coupled with the fact that I think, the interest rate is probably toppish, right, moving forward. So I think our assessment is that probably on a forward basis, we should be, you know, quite confidently trading in the 3%-2.5% of region. Yeah.
John?
So our forecast for 2024 expect that we'll be in the mid to high fours, which I think probably reflects a greater mix of U.S. dollar-denominated debt. And, you know, judging from the forward curve, we'd expect or hope next year would be in the low fours.
Maybe just a bit on capital structure again, 'cause I mean, one of the initiatives would be, you know, looking at acquisitions, et cetera. John, just on your side of things, where do you think your optimal capital structure would be in terms of gearing levels?
In terms of gearing levels. We are, you know, a little bit fortunate today. Part of the customer bankruptcy resolution, we were able to sell a couple of assets, and so we generated $160 million of proceeds from the sale of a couple of assets. And then we also raised an equity fundraising in February as well. And so we're, you know, we have cash on the balance sheet today. We're under-levered on a net debt basis. And so, you know, our comfort range, our target range is 35%-40% leverage. Probably prefer to err, a little closer to the lower end of the range in a somewhat uncertain environment. But we, you know, we're fortunate that we've got some headroom where we are today, particularly on the heels of that capital-raising activity.
Okay, I think, I think from my end as well, I think similarly, while today, of course, I think in the S-REIT sector, there is, you know, officially, up to 50% the LTV limit for Singapore-listed REITs, right? For us, I think our internal rule of thumb is to keep below 40, right? At this juncture, similarly, I think we do have some level of headroom in that sense. Today, we are trending in the 37%-38% LTV percentages. So I think, I think, yeah, we do have some headroom, right, for us to do acquisitions as well. Yeah.
Thank you. Maybe too, just to close off the session, just going to our rapid-fire questions. Well, we need some guidance. So maybe, Hwee, let me start with you first, just in terms of, you know, what would be the same-store NOI growth for your portfolio going to 2025?
Wow. I think it really depends on, you know, how we grow the portfolio from a growth perspective. Because I think historically, if you look at the Digital Core REIT, right, it's really set up to be a very stable type of product, right? And if you look at our key metrics, you know, occupancy, we are close to 98%, right?
From that perspective, to continue to drive, especially in the environment like today, where there's high inflation, right, to the earlier discussion, I think what we have been able to do is really to drive reversionary upticks, right, in the very strong markets of Singapore, Ireland, such that we continue to be able to deliver, I think, very resilient of year-on-year NOI, you know, growth, right? But of course, I think the big kicker is really, you know, the big question mark is depending on how we grow it in terms of new additions to the portfolio. I think that will be the part where we will, you know, if we are lucky, I think in some of those initiatives, right, that will be able to drive more meaningful NOI pick-ups.
Okay. This one will be more same-store NOI. It's just like existing portfolio, so-
Ye ah. Okay.
It's, uh-
Then we should be able to continue, I think, a very stable and, you know, with good growth. Yeah.
Okay. John?
So I'll, maybe answer it a little bit differently. Rather than giving 2025 guidance, I'd say that expectation for the sector, you know, should be 4%-5%.
Okay. We'll just keep responses to just one bullet point. So will your property sector have more, fewer, or the same number of public companies one year from now, John?
Same.
Well-
No, I think there might be more.
Okay. And then, Hwee Long what is your best real estate decision today? Is it to buy, sell, redevelop, or repurchase stock?
The repurchase the what? The stock, is it?
Y eah.
I think you should buy.
Okay. John?
We're.