REIT Pays $148m for Data Centers in San Francisco, Atlanta

San Francisco-based Digital Realty Trust announced on January 4th that it had acquired a pair of U.S. data centers, spending $148m in the deals to add approximately 500k of operating square footage. The publicly-traded REIT and data center provider added facilities in San Francisco and Atlanta, raising the number of properties in its global portfolio to 100. The transactions continue a red hot market for technology-related real estate, with data center M&A showing no signs of slowing down in 2012.

Digital Realty stayed close to home with its San Francisco data center purchase, picking up a multi-tenant facility located at 360 Spear Street, which abuts one of its existing co-location facilities in downtown San Francisco. It paid $85m for the 155-square-foot building. Verizon, AT&T and co-location provider ColoServe are current tenants of the property.

The Atlanta facility acquired by Digital Realty, at 344k square feet, is more than double the size of its San Francisco purchase. It paid $63m to acquire the three-story property from an unnamed U.S. based airline. The deal however was structured as a sales leaseback transaction, with seller signing a new ten-year lease with Digital Realty. The airline will continue to occupy nearly half of the building, while the remaining space is leased long-term to a second, unnamed tenant.

Long term predictability of rental revenue, which fully-leased properties provide, is attractive to Digital Realty. As an acquisition strategy, Digital Realty targets properties presently occupied by quality corporate customers that are locked into long-term commitments. Both 360 Spear Street and the Atlanta facility were 100% leased at the deals’ close. As of 3Q11, Digital Realty’s 98 properties had an average occupancy rate of 94%. By comparison, the utilization rate for ILEC Cincinnati Bell’s data center co-location segment was 86% for the same time period. For data center operators, carrying un-leased operating space translates into forgone revenue.

While there is no public financial information on the two recently acquired data centers, historical data from Digital Realty’s existing properties provides us with some insight into how these latest acquisitions may impact Digital Realty’s top line.

According to its 2010 annual report, Digital Realty commanded approximately $84 in annualized rent per occupied square foot from its three San Francisco data centers, indicating 360 Spear Street could generate in the range of $13m annually. The company’s existing Atlanta property on the other hand—a 314k square foot facility it acquired for $25m in 2006—produced just $4.5 in annualized rent per square foot in 2010, pointing to a lower earning potential for Digital Realty’s new Atlanta purchase.

Comparing the purchase price multiples for the deals reinforces that the San Francisco property should generate more revenue than the Atlanta facility. Digital Realty paid $548 per operating square foot for 360 Spear Street and just $183 per operating square foot for the Atlanta property. Carter Validus, a fellow REIT, also paid a relatively low price of $280 per square foot when it purchased its Altanta-based data center back in November. By comparison, the average price paid per square foot in recently observed data center deals has been around $655.

While location plays a large factor into the price that buyers such as Digital Realty are willing to pay for data centers, the driving force behind the rent revenues generated by properties are the services demanded by the lessees. Digital Realty’s top of the line “turn-key data center” product, which offers customers dedicated, managed suites with no shared infrastructure with other clients, commands approximately $180 in annual rent revenue per square foot. At the opposite end of the spectrum, its “powered base building” product, which essentially provides customers with the bare-bones facilities in which to develop their own data centers, generates around $20 per square foot in annual rental revenue.

Given the growing demand for technology-related real estate, Digital Realty is experiencing top line growth from all of its data center products, and the market has rewarded the company with a higher stock price. The company’s share price recently hit its 52-week high of $68.01 on January 3rd and investors are trading Digital Realty at bullish levels of 9.2x revenue and near 17x cash flow. Meanwhile, the publicly-traded ILECs continue to trade at around 2x revenue and 6x cash flows—just another reason you can expect to see more and more telcos invest in data centers during 2012.