Digital Realty (NYSE: DLR) and Realty Income Corp. (NYSE: O) this week announced the companies' establishment of a joint venture to support development of two build-to-suit data centers in Northern Virginia.
The partnership marks blue-chip net-lease REIT Realty Income's first investment in the data center sector. Digital Realty’s president and CEO, Andy Power, registered enthusiasm about the partnership.
"The formation of this development joint venture supports our customer's build-to-suit requirements with a like-minded, long-term investor as our partner," he said.
A new analyst brief from Zacks Equity Research called the partnership a strategic move that not only augurs well for the growth prospects of both companies, but also signifies rising overall investor confidence in the data center market.
The investment researcher noted that, as data storage and processing demands continue to surge, such joint ventures, especially in key markets like Northern Virginia, position companies to strategically capitalize on the evolving needs of businesses.
"The transaction also further bolsters and diversifies Digital Realty's capital sources, while enhancing our flexibility, so that we can prudently support our stakeholders' longer term capacity requirements," added Digital Realty's Power.
In the partnership, Realty Income acquires 80% equity interest in two data centers currently under construction in Northern Virginia, with up to 48 MW of potential IT load.
As recently well-noted by Site Selection's Ron Starner, as the world's first and foremost data center hub (a fact also reflected by NPR's latest reckoning) at almost 2 GW of capacity, Northern Virginia is roughly 3x the size of the next largest data center market in the world.
Northern Virginia also accounts for approximately half of all built data center space in the U.S., per CBRE estimates.
In the Digital Realty - Realty Income transaction, the REIT invested approximately $200 million to acquire its equity interest in the joint venture, while Digital Realty maintains a 20% interest.
Each partner will fund its pro rata share of the remaining $150 million estimated development cost for the first phase of the project, which is slated for completion by mid-2024.
"One of Realty Income's core strategies is to partner with companies that are leaders in their respective industries," explained Sumit Roy, Realty Income's President and CEO.
Roy continued, "To that end, for our initial investment in the net lease data center vertical, we are pleased to partner with Digital Realty, the largest provider of cloud- and carrier-neutral data centers whose global platform is well respected in the industry."
Realty Income is structured as a REIT, with monthly dividends supported by the cash flow from over 13,250 real estate properties, primarily owned under long-term net lease agreements with commercial clients.
To date, the company states it has declared 641 consecutive common stock monthly dividends throughout its 54-year operating history, and increased dividend 122 times since its public listing in 1994.
The partners expect the new data centers in Northern Virginia to generate a 6.9% initial cash lease yield upon lease commencement in mid-2024. The facilities are subject to a 10-year initial lease term with extension options and 2.0% annual rent escalators.
"This transaction offers our stockholders attractive risk-adjusted returns and will support the development of two state-of-the-art facilities located in Northern Virginia, the largest data center market in the world," affirmed Realty Income's Roy.
The Data Centers
The two build-to-suit data centers being raised in Northern Virginia began construction in the fourth quarter of 2022.
The facilities are slated to deliver 16 MW of initial data center capacity, but that capacity is expandable up to 48 MW at the client's option.
As is common in the industry, the build-to-suit facilities under construction were 100% pre-leased to an S&P 100 investment grade client prior to groundbreaking.
The budget for the first phase of the construction projects, characterized as yield-on-cost developments, is approximately $400 million.
Digital Realty noted that the client maintains the option to expand the projects up to 48 MW of total capacity during the initial lease term - which could increase the project's budget up to $800 million, based on current development cost estimates.
PlatformDIGITAL, Digital Realty's global data center platform, leverages the company's Pervasive Datacenter Architecture (PDx) solution methodology across its footprint of 300-plus facilities in 50-plus metros across more than 25 countries on six continents.
Data Center Boom Brooks Little Skepticism
Equity analyst Zacks further characterized the new collaboration between Digital Realty and Realty Income as "a testament to the dynamism and growth potential of the data center industry."
"As technology evolves, the demand for reliable and scalable data solutions is set to soar, and this joint venture positions both companies as key players in meeting these demands," averred the analyst, adding, "Investors keen on exposure to the data center sector should keep a watchful eye on the developments stemming from this strategic partnership."
As tangentially and recently noted by BISNOW's data center reporter, Dan Rabb:
Speaking with Wall Street analysts in late October, Digital Realty’s leadership hinted that this kind of development joint venture was on the horizon.
Although the firm is one of the largest global operators and developers in the booming data center sector, Digital Realty has faced skepticism from investors over its ability to fund growth while simultaneously increasing liquidity and lowering its debt load from levels that had Wall Street nervous.
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