High capital expenditure, tech changes could dampen outlook for data-centre S-Reits

ANALYSTS are optimistic that Singapore-listed real estate investment trusts (S-Reits) with exposure to data-centre assets will benefit from plans announced in Budget 2024 to ride on the artificial intelligence (AI) boom.

However, they warned that high capital expenditure or significant changes to technology could dampen the growth of these Reits.

The government earlier this month announced it will invest more than S$1 billion over the next five years to develop AI infrastructure, talent and the industry.

It is also upgrading Singapore’s broadband network and enhancing energy efficiency grants for various sectors, including data centres.

But market watchers were mixed in their outlook, with one describing it as “premature” to say that the AI boom would boost data-centre S-Reits.

The signs, however, are pointing in the right direction.

In a recent report, commercial real estate services firm Cushman & Wakefield said it expects demand for data centres to expand by about 25 per cent a year to 2028 in South-east Asia and North Asia, compared to 14 per cent a year in the US.

In Singapore, Reits with exposure to data-centre assets, such as Digital Core Reit and CapitaLand Ascendas Reit , were among the best performers last year.

According to Singapore Exchange (SGX) data, these data-centre S-Reits outperformed their peers, generating total returns of between 8.5 per cent and 23.3 per cent in 2023. In comparison, the iEdge S-Reit Index managed total returns of 6.6 per cent over the same period.

Maybank analysts Chua Hak Bin and Brian Lee said Reits such as CapitaLand Ascendas Reit and Mapletree Industrial Trust , which have high-tech focused spaces and data centres, were likely to benefit in the medium term, with higher research and development-related tax rebates and potential collaborations with AI companies.

Mixed performance

Market watchers warned, however, that the outlook for data centres may not be all rosy.

They noted that the performance of S-Reits with exposure to data centres, such as Digital Core Reit, CapitaLand Ascendas Reit, Keppel DC Reit and Mapletree Industrial Trust, were mixed in the last five years.

S-Reits with data-centre exposure, such as Capitaland Ascendas and Mapletree Industrial, climbed 11 per cent and 27 per cent respectively over the last five years, even as the FTSE Reit Index fell about 13 per cent over the same period.

Among pure-play data-centre Reits, Keppel DC Reit rose 24 per cent in the last five years. On the other hand, Digital Core Reit, which listed in December 2021, fell 43 per cent.

Maybank analyst Krishna Guha attributed the mixed performance to sector- and stock-specific factors.

Sector-specific factors include interest rate hikes and the impact of the Covid-19 pandemic, which shifted the flow of funds towards industrial Reits over commercial or hospitality Reits.

Stock-specific factors refer to the level of tenant, asset class and geographic diversification, as well individual debt metrics of the Reit.

In the case of Mapletree Industrial Trust and CapitaLand Ascendas Reit, veteran Reit investor Gabriel Yap said their growth was due to their key assets such as warehouses, which benefited from the rise in rentals over the pandemic period.

Corporate-governance management also led to the mixed performance of the Reits, said Yap, who is the executive chairman of investment firm GCP Global.

Besides the growth of AI, other factors affect the demand of data centres, and consequently their stock performance, said analysts.

The capital expenditure required to upgrade data centres to cope with more intensive usage, for instance, could dampen the performance of data-centre Reits, said UOB Kay Hian analyst Jonathan Koh.

Yap said that the Reits’ performances would depend on skilful capital management. This means “a good mixture” of the cost of funds, interest cover and gearing.

Other factors, such as demand from start-ups and requirements on data localisation, would also affect the performance of data-centre Reits, said Maybank’s Guha.

He said: “Computing and bandwidth costs have fallen over time, but any step change in technology can make old equipment redundant, and this is hard to predict.”

Mixed outlook

Analysts were mixed in their outlook for data-centre Reits, with some more optimistic than others.

Koh said that he expects there to eventually be a “positive impact” on the performance of such Reits as the supply of data centres is “quite constrained”. These Reits can charge higher rent upon the expiry of current leases, given the strong demand for data-centre spaces.

However, he said that the positive impact will take time to materialise, given that the leases of data centres can run for up to 10 years.

On the growth rate of Reits, Guha said that he expects data-centre spot rents to go up.

At the same time, vacancy in older assets will increase as demand moves towards data centres which are able to handle AI-configured servers, he added.

Yap said it was “too premature” to make the call that data-centre Reits would benefit from AI.

He noted that none of the data-centre Reits own hyperscale data centres, which can directly benefit from an AI boom. Hyperscale data centres are larger and have higher processing volume than regular centres.

“If you tell me any of these data centres Reits actually own a hyperscale centre, then I would say: ‘Yes, you are definitely in the position to benefit from the AI boom’. If not, then it’s a wait-and-see (situation),” he said.