Prudential, Digital Realty Deal Could Boost Data Center Investment

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This data center in Silicon Valley is among those included in a new joint venture between Digital Realty and Prudential Real Estate Investors. (Photo: Digital Realty)

Prudential Real Estate Investors (PREI) has teamed with Digital Realty Trust on a $369 million joint venture to operate fully-leased corporate data centers. The deal provides cash for Digital Realty, which is contributing nine facilities. The participation by Prudential is a vote of confidence in data centers as an asset class that is attractive to real estate investors.

By packaging properties with high-quality corporate tenants, Digital Realty (DLR) has made the portfolio attractive to "core" real estate investors like Prudential, who typically pursue a conservative strategy that focuses on stable properties with low investment risk. Establishing data centers as core assets opens the sector up to a broader range of institutional real estate investors, which in turn could boost data center investment by making it easier to find financing and buyers for projects.

"We are delighted to be partnering with an institution of PREI's caliber, and we believe this transaction represents an important validation of the appeal of data centers as an asset class to a sophisticated, core real estate investor," said Michael Foust, Digital Realty's Chief Executive Officer.

Focus on Powered Base Buildings

The joint venture includes nine fully-leased data centers that were leased as Powered Base Buildings, an approach in which Digital Realty provides the tenant with a shell that the tenant builds out for data center use. The buildings, which total 1.06 million square feet, are valued at $366.4 million (excluding $2.8 million of closing costs), or $346 per square foot. The PREI-managed fund will take an 80 percent interest in the joint venture and Digital Realty will retain a 20 percent interest.

PREI receives rent from the properties (estimated at $24.5 million a year for 2013), while Digital Realty will receive $328 million for the sale to the JV and ongoing fees for managing the properties.

"The long lease terms and contractual rental rate increases on these Powered Base Building data centers provide a stable rental income stream that represents a good fit with our investment objectives," said Cathy Marcus, managing director at PREI and senior portfolio manager of the firm's core U.S. real estate strategy. "These institutional quality properties are fully leased to a diversified roster of credit tenants, and we look forward to realizing a stable return on this portfolio over the course of a long-term relationship with Digital Realty."

High Tenant Credit Quality

Digital Realty didn't identify the tenants. But based on an analysis of Digital's portfolio, DCK believes the tenants include Equinix, Amazon, Verizon and CenturyLink (Savvis). The quality of the tenants is critical to making these data centers more attractive to investors.

The data center sector has long been viewed with caution by institutional real estate investors, who see it as a specialized, capital-intensive properties with a history of tenant credit problems dating to the dot-com bust, when many companies that built data centers experienced losses when unprofitable startup tenants went bankrupt of defaulted on their leases. The risk profile of the data center sector has changed dramatically over the past decade, as developers like Digital Realty have pursued new deployment models that manage capital more carefully. Operators have also focused on tenant credit quality.

That approach has won over Prudential Real Estate Investors, which has a global portfolio valued at about $53 billion. The joint venture could set a precedent by establishing data centers as a successful core real estate investment, which would broaden the pool of potential investors. Thus, while the deal has immediate benefits for Digital Realty, over the long-term it could create more options for data center developers seeking buyers for their properties (other than Digital Realty).

The joint venture has arranged a $185 million five-year unsecured bank loan from US Bank and SunTrust at LIBOR plus 180 basis points, representing a loan-to-value ratio of approximately 50 percent.