Fitch Ratings has assigned initial credit ratings to Digital Realty Trust, Inc. (NYSE: DLR) and its operating partnership, Digital Realty Trust, L.P. (collectively, 'Digital Realty') as follows:
Digital Realty Trust, Inc.
--Issuer Default Rating (IDR) 'BBB';
--$159.8 million redeemable preferred stock 'BBB-';
--$502.5 million convertible preferred stock 'BBB-'.
Digital Realty Trust, L.P.
--IDR 'BBB';
--$750 million unsecured revolving credit facility 'BBB';
--$83 million senior unsecured notes 'BBB';
--$438.9 million senior unsecured exchangeable debentures 'BBB'.
The Rating Outlook is Stable.
In Fitch's opinion, Digital Realty, a real estate investment trust (REIT) that owns a diversified portfolio of datacenters and other technology real estate, has a credit profile consistent with a 'BBB' IDR due to three factors: the size of its unencumbered property pool and unencumbered cash flow, leverage levels as measured by net debt to recurring operating EBITDA, and demonstrated access to various sources of capital providing financial flexibility.
Digital Realty's unencumbered property pool is sizable and unencumbered cash flows are robust due to rising demand for datacenter space specifically in a challenging environment for commercial real estate generally. As of Sept. 30, 2009, the unencumbered pool consisted of 59 properties, which provides a solid foundation for unsecured lenders considering that the overall portfolio consists of 108 buildings comprising 79 properties. These properties include Internet gateways and corporate datacenter properties providing Turn-Key and Powered Base Building solutions, and to a lesser extent, technology manufacturing and office properties.
This diversified unencumbered pool covered unsecured debt by 3.3 times (x) as of Sept. 30, 2009 based on the methodology employed in the company's credit agreement, which utilizes a weighted average cap rate of approximately 8% on unencumbered net operating income. Fitch views the company's unencumbered asset coverage ratio as strong for a 'BBB' IDR. In addition, the company's unencumbered property cash flow was strong with unencumbered asset net operating income (NOI) to unsecured interest expense of 5.1x for 2009 year-to-date.
The company employs a conservative amount of leverage, and has reduced leverage over the past several years. As of Sept. 30, 2009, the company's net debt to recurring operating EBITDA ratio was 4.0x, compared with 4.3x as of Dec. 31, 2008 and 6.0x as of Dec. 31, 2007. The strength of this ratio is mitigated by the relatively limited history of datacenter property earnings relative to the earnings of other REITs. However, in Fitch's view, Digital Realty has a track record of improving earnings through redevelopment as demonstrated by same-store NOI growth of 18.1% in 2008 and a weighted average of 26.7% for the year-to-date period ended Sept. 30, 2009. Given this track record, Fitch believes that net debt to recurring operating EBITDA is not likely to increase above 5.0x in the near term.
The 'BBB' IDR and senior unsecured debt ratings further reflect Digital Realty's proven access to various forms of capital, including unsecured revolving credit, privately held senior unsecured notes, senior unsecured exchangeable notes, redeemable preferred stock, convertible preferred stock and common stock. This access provides a flexible capital structure with which to fund acquisitions and development and address maturing indebtedness. Recent financing activities include a $30 million commitment from Morgan Stanley under Digital Realty's revolving credit facility, bringing the total commitment size to $750 million, as well as mortgage financings on three European properties. Given the company's stock performance, common stock offerings also remain attractive to the company while providing additional cushion to unsecured lenders and positioning the company away from financial covenant limitations in its credit agreements. In Fitch's view, Digital Realty's covenants do not restrict the company's financial flexibility.
The ratings take into consideration certain offsetting factors including tenant concentration and tenant credit risk, the company's secured debt borrowing base, and Fitch's expectation that fixed charge coverage may moderate in the event that the company executes a public unsecured bond offering.
The company's top two tenants, SAVVIS, Inc. and Equinix, Inc., constituted 9.6% and 5.0% of Digital Realty's annualized rental revenue in third-quarter 2009, indicating that while tenant concentration has declined over the past several years, the company's exposure to its top two tenants remains material. However, the company's overall tenant roster remains highly granular with approximately 330 tenants, and includes managed service and network companies, colocation providers, and corporate enterprise users.
As a result of the exchangeable debenture transaction that Digital Realty completed in April, the company's secured debt borrowing base became a smaller component of the company's overall borrowing base. Secured debt as a percentage of undepreciated book capital and as a percentage of total debt was 25.5% and 58.5%, respectively, as of Sept. 30, 2009, compared with 31.6% and 74.1%, respectively, as of Dec. 31, 2008. Though the company's secured debt borrowing base as of Sept. 30, 2009 remains somewhat high for the 'BBB' rating level, Fitch anticipates that the company's secured debt as a percentage of total debt and as a percentage of undepreciated book capital will improve pro forma for an unsecured bond transaction.
Digital Realty's operating performance is driven by adjusted gross lease rents on Turn-Key datacenters in which energy costs are passed through to customers and triple net lease rents on Powered Base Building space. Leases typically include 3% annual rent bumps and terms of approximately 10 years, and Digital Realty recently demonstrated 10%-15% lease rollover rates. As such, the company's fixed charge coverage ratio (defined as recurring EBITDA less recurring capital expenditures less straight line rent adjustments divided by interest expense, capitalized interest and preferred dividends) is solid at 2.2x for the trailing 12 months ended Sept. 30, 2009. Fitch anticipates that fixed charge coverage will remain approximately 2.5x in a base case that assumes contractual lease bumps of approximately 3% for non-expiring leases and lease rollover rates of approximately 10% for expiring leases. However, fixed charge coverage could fall below 2.0x in a stressed environment that Fitch does not anticipate if leasing were to come under pressure or major tenants were to vacate (Fitch's stress case is derived from 'Updated Criteria for U.S. Equity REIT Risk-Adjusted Earnings,' dated Aug. 10, 2009 and available on the Fitch web site at 'www.fitchratings.com', in which the average annual same-store NOI decline for office and industrial properties is 8%).
The one-notch differential between Digital Realty's IDR and the 'BBB-' rating of the company's preferred stock is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on Fitch's criteria report on 'Equity Credit for Hybrids & Other Capital Securities,' dated June 25, 2008, also available at 'www.fitchratings.com', the company's preferred stock is 75% equity-like and 25% debt-like, since it is perpetual and has no covenants but has a cumulative deferral option or conversion feature. Net debt plus 25% of preferred stock to recurring operating EBITDA and debt plus 25% of preferred stock to undepreciated book capital were 4.5x and 48.1%, respectively, as of Sept. 30, 2009.
The Stable Rating Outlook takes into account the company's liquidity position and Digital Realty's management team. For Sept. 30, 2009 to Dec. 31, 2011, the company's sources of liquidity (cash, availability under the company's revolving credit facility and expected retained cash flows from operating activities) covered uses of liquidity (expected debt payments and maturities and recurring capital expenditures) by 2.8x, providing stability to Digital Realty's ability to fund acquisitions, development, and capital expenditures and address maturing indebtedness.
Fitch believes that Digital Realty's creditworthiness will continue to be supported by the company's management team with respect to real estate investment management, financial strategy, and technical expertise. For example, the management team's design of its POD Architecture modular datacenter configuration provides cost savings to tenants and cash flow stability. In addition, the company's pursuit of Leadership in Energy and Environmental Design (LEED) certifications by the U.S. Green Building Council, including the LEED Platinum Certification awarded for a recently completed datacenter in Santa Clara, CA demonstrates management's goals of energy efficiency and corporate responsibility.
The following factors may have a positive impact on the ratings:
--Fixed charge coverage remaining above 3.0x;
--Net debt to recurring operating EBITDA remaining below 4.0x;
--Further tenant diversification;
--Growth in the unencumbered portfolio.
The following factors may have a negative impact on the ratings:
--Fixed charge coverage remaining below 2.0x;
--Net debt to recurring operating EBITDA remaining above 6.0x;
--A liquidity shortfall;
--Unencumbered asset coverage of unsecured debt falling below 2.0x based on calculations under the company's credit agreements.
Digital Realty is an equity REIT headquartered in San Francisco, CA with $4 billion in undepreciated book assets and a total market capitalization of $6 billion as of Sept. 30, 2009. As of Sept. 30, 2009, Digital Realty's portfolio consisted of 79 properties, including one property held as an investment in an unconsolidated joint venture, located throughout North America and Europe comprising 13.8 million square feet.
Additional information is available at 'www.fitchratings.com'. The ratings above have been initiated by Fitch as a service to investors.
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