Fitch Affirms Digital Realty Trust's IDR at 'BBB'; Outlook Stable
NEW YORK -- December 4, 2013
Fitch Ratings has affirmed the credit ratings of Digital Realty Trust, Inc.
(NYSE: DLR) and its subsidiaries (collectively, Digital Realty) as follows:
Digital Realty Trust, Inc.
--Issuer Default Rating (IDR) at 'BBB';
--$720 million preferred stock at 'BB+'.
Digital Realty Trust, L.P.
--IDR at 'BBB';
--$2 billion unsecured revolving credit facility 'BBB';
--$950.2 million senior unsecured term loan at 'BBB';
--$1.7 billion senior unsecured notes at 'BBB';
--$266.4 million senior unsecured exchangeable notes at 'BBB'.
Digital Stout Holding, LLC
--IDR at 'BBB';
--GBP400 million unsecured guaranteed notes at 'BBB'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
The affirmation of Digital Realty's IDR at 'BBB' takes into account the
company's strong access to capital evidencing increasing institutional
acceptance of the company's data center portfolio, as well as adequate
liquidity due to laddered debt maturities, moderate retained cash flow and a
less aggressive development pipeline. Credit strengths also include a global
platform, limited tenant concentration, and a seasoned management team.
These strengths are balanced by uncertainties involving the leasing
environment following reduced occupancy rates and select rental rate roll
downs; however, fixed-charge coverage should remain appropriate for the 'BBB'
rating. Corporate leverage is low for the rating although unencumbered asset
coverage is somewhat weak for the 'BBB' level as the company's unsecured debt
incurrence has outpaced the growth of the unencumbered pool.
Leasing Environment Uncertainties
Same-property net operating income (NOI) declined by 0.6% year-over-year in
the third quarter of 2013 (3Q'13) following growth of 7.7% in 2Q'13 and 8.1%
in 1Q'13, driven primarily by a non-cash straight-line rent adjustment booked
during 3Q'13 (excluding this adjustment, same-property NOI growth would have
been +4.4%). In addition, same-store occupancy decreased to 91.8% as of Sept.
30, 2013 from 93.7% as of Dec. 31, 2012, principally due to a sizeable
non-data center asset lease expiration. Cash rental rate roll downs on renewal
were negative 5% on average for the year-to-date period ended Sept. 30, 2013.
Rental roll downs are possible in 2014 when 9.4% of rents expire as well as in
2015 when 8% expires. Nevertheless, the company sees an opportunity to
increase revenues from colocation i.e., providing space, power, connectivity
and outsourced IT solutions for corporate enterprises. Colocation provides an
alternative vehicle for growth that would enhance DLR's revenue diversity to
the benefit of unsecured bondholders.
Tenant retention was high at 92% for the year-to-date period ended Sept. 30,
2013, indicating that only select tenants have chosen not to renew in favor of
building their own data centers, which is a secular data center industry risk.
In addition, the weighted average remaining lease term for the portfolio is
approximately 6.9 years, providing cash flow stability absent tenant
Solid Fixed-Charge Coverage
The company's fixed-charge coverage ratio was strong for the 'BBB' rating at
3.0x for the trailing twelve months (TTM) ended Sept. 30, 2013, compared with
3.0x in 2012 and 2.9x in 2011. Fitch defines fixed-charge coverage as
recurring operating EBITDA less recurring capital expenditures less
straight-line rent adjustments divided by total cash interest incurred and
preferred stock dividends.
Fitch anticipates that a backlog of leases signed but not yet commenced will
offset potential further rent roll downs and increased capital expenditures
associated with the lease-up of vacant space. Fixed-charge coverage should
remain solid for the 'BBB' rating in the high 2.0x range. In a stress case not
anticipated by Fitch in which rental rate roll downs result in low single
digit same-store NOI declines, coverage would decline to 2.5x, which would
remain adequate for a 'BBB' rating.
Reduced Development Pipeline
Fitch views favorably DLR's reduction in development activities in response to
market conditions. DLR's direct costs to-be-spent represented 5.2% of gross
asset value as of Sept. 30, 2013 compared with 6% as of year-end 2012 and 6.9%
as of year-end 2011. Total construction-in-progress is approximately 25.1%
pre-leased as of Sept. 30, 2013, indicative of elevated lease-up risk.
Construction costs on a per-square foot basis are declining as well but remain
high compared with other commercial property sectors.
Strong Access to Capital
The company continues to demonstrate strong access to multiple sources of
capital on favorable terms. In January 2013, Digital Stout Holding, LLC issued
GBP400 million of its 4.25% guaranteed notes due 2025 and in April 2013, the
company issued $250 million of 5.875% series G preferred stock. In August
2013, the company refinanced its revolving credit facility, increasing its
total borrowing capacity to $2 billion from $1.8 billion and also refinanced
its senior unsecured multi-currency term loan facility, increasing its total
borrowing capacity to $1 billion from $750 million.
In September 2013, DLR formed a joint venture with an investment fund managed
by Prudential Real Estate Investors (PREI) and contributed nine Powered Base
Building data centers valued at approximately $366.4 million. The PREI-managed
fund took an 80% interest in the joint venture and DLR retained a 20%
Liquidity coverage assuming no additional capital raising, calculated as
liquidity sources divided by uses, is 1.1x for the period Oct. 1, 2013 to Dec.
31, 2015. Sources of liquidity include unrestricted cash, availability under
the company's global credit facility, and projected retained cash flows from
operating activities after dividends and distributions. Uses of liquidity
include debt maturities and projected recurring capital expenditures and
Assuming 80% of the company's secured debt is refinanced--a scenario not
likely as the company continues to unencumber the portfolio--liquidity
coverage would be 1.3x. Debt maturities are laddered in the coming years with
3.3% of debt maturing in 4Q'13 followed by 9.3% in 2014 and 10.8% in 2015. In
addition, the company's adjusted funds from operations (AFFO) payout ratio was
83.4% in 3Q'13 after averaging 81.5% in 2012 and 77.8%, reflective of good
Digital Realty offers Turn-Key Flex, Powered Base Building, and colocation
space and its 130 properties span 33 markets across 10 countries and four
continents. This significant market presence gives the company strong tenant
relationships; approximately 58% of the company's customers occupancy space in
DLR data centers across multiple markets. Top markets as of Sept. 30, 2013
were London (11.7% of rent), Northern Virginia (9.7%), Dallas (9.2%), New York
(8.8%), and Silicon Valley (8.3%).
Limited Tenant Concentration
Tenant concentration continues to decline, which Fitch views favorably and
which differentiates DLR from its major competitors, CoreSite Realty
Corporation, DuPont Fabros Technology, Inc. and Global Switch Holdings Ltd.
(Fitch IDR of 'BBB' with a Stable Rating Outlook). DLR's top five tenants
comprise 23.3% of total base rent, compared with 23.1% to 61% for its primary
competitors. DLR's top tenants as of Sept. 30, 2013 were CenturyLink, Inc.
(IDR of 'BB+' with a Stable Rating Outlook) at 8.1% of rent, IBM (IDR of 'A+'
with a Stable Rating Outlook) at 4.9%, TelX Group, Inc. at 4.4%, Equinix
Operating Company, Inc. at 3.2% and Morgan Stanley (IDR of 'A' with a Stable
Rating Outlook) at 2.7%.
Technical Team Focused on New Initiatives
The company offers customized solutions to its tenants; recent initiatives in
2013 include the launch of EnVision, a comprehensive data center
infrastructure management (DCIM) solution that provides increased visibility
into data center operations, and the launch of Digital Open Internet Exchange
(Digital Open-IX), a neutral and member-governed internet exchanges
self-regulatory body in North America, similar to the system in Europe. The
initial rollout for Digital Open-IX will take place in the New York metro area
and Northern Virginia, followed by deployment in several other U.S. markets.
Low Corporate Leverage for 'BBB'
Leverage is low for the 'BBB' rating, with net debt as of Sept. 30, 2013 to
latest 12 months (LTM) recurring operating EBITDA at 5.6x compared with 5.6x
as of Dec. 31, 2012 and 4.7x as of Dec. 31, 2011. The incurrence of debt to
fund a portion of acquisitions and development contributed towards the trend.
Fitch's base case anticipates that the company's same-property NOI will be
flat over the next 12-to-24 months, which will result in leverage in the
low-to-mid 5x range. In a stress case not anticipated by Fitch in which the
company experiences low single digit same-store NOI declines, leverage would
approach 6.0x, which would be weak for a 'BBB' rating. Separately, in October
2013, DLR's board of directors authorized a $500 million share repurchase
program although the company has yet to utilize the program. Fitch does not
expect the company to access this program heavily; should the company do so,
it would weaken the position of unsecured bondholders.
Slightly Weak Unencumbered Asset Coverage
Digital Realty is committed to an unsecured funding profile. However, the
company's unsecured debt incurrence has outpaced the growth of the
unencumbered pool. Unencumbered assets (3Q'13 unencumbered NOI pro forma for
redevelopment and development NOI divided by a stressed capitalization rate of
10%) covered unsecured debt by 1.9x as of Sept. 30, 2013. Third quarter 2013
actual unencumbered asset coverage was 1.7x, down from 2.0x as of Sept. 30,
2012 and Fitch anticipates that unencumbered asset coverage will be 1.8x based
on cost remaining to be spent on development.
Preferred Stock Notching
The two-notch differential between Digital Realty's IDR and its preferred
stock rating is consistent with Fitch's criteria for corporate entities with
an IDR of 'BBB'. Based on Fitch's criteria report, 'Treatment and Notching of
Hybrids in Nonfinancial Corporate and REIT Credit Analysis,' dated Dec. 13,
2012, the company's preferred stock is deeply subordinated and has loss
absorption elements that would likely result in poor recoveries in the event
of a corporate default.
The Stable Outlook reflects Fitch's projection that fixed charge coverage will
remain in the high 2x to low 3x range, that leverage will remain in the
low-to-mid 5x range, and that the company will continue its gradual tenant and
asset diversification via acquisitions and development.
The following factors may result in positive momentum in the rating and/or
--Increased mortgage lending activity in the datacenter sector;
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x
(fixed-charge coverage for the TTM ended Sept. 30, 2013 was 3.0x);
--Fitch's expectation of net debt to recurring operating EBITDA sustaining
below 4.5x (Sept. 30, 2013 leverage was 5.6x).
The following factors may result in negative momentum in the rating and/or
--Sustained declines in rental rates and same-property NOI;
--Fitch's expectation of fixed-charge coverage sustaining below 2.5x;
--Fitch's expectation of leverage sustaining above 6.0x;
--Base case liquidity coverage sustaining below 1.0x.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--Recovery Ratings and Notching Criteria for Equity REITs (Nov. 19, 2013);
--Corporate Rating Methodology (Aug. 5, 2013);
--Criteria for Rating U.S. Equity REITs and REOCs (Feb. 26, 2013);
--Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Analysis (Dec. 13, 2012).
Applicable Criteria and Related Research:
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Criteria for Rating U.S. Equity REITs and REOCs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
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