Fitch Ratings has affirmed the ratings of Digital Realty Trust, Inc. (NYSE: DLR), Digital Realty Trust, L.P., and Digital Intrepid Holding B.V., including the Long-Term Issuer Default Ratings (IDRs) and unsecured debt at 'BBB'.

Fitch has also affirmed the unsecured debt at Digital Dutch Finco B.V., Digital Euro Finco, LLC, Digital Constellation, B.V., and Digital Stout Holding, LLC at 'BBB'. The Rating Outlook is Stable.

The affirmation and Stable Outlook reflect the issuer's historical compliance with its financial policy, global scale, predictable cash flow profile, and diversified and consistent access to capital. The Stable Outlook also considers the issuer's public commitment to reducing leverage from its current elevated levels through EBITDA growth, meaningful dispositions and moderated investment spend.

Key Rating Drivers

Deleveraging Through Rating Horizon: Fitch expects DLR to have reduced its leverage (net debt before preferred to recurring operating EBITDA after distributions to/from associates and minorities) below 6x by the end of 2024 through a combination of EBITDA growth, asset sales, joint ventures, moderated investment activity and proceeds from equity sales. The company has been successful at raising non-recourse debt at joint ventures as well as issuing meaningful amounts of equity (more than $2 billion in 2023) which helps to drive down consolidated leverage. REIT leverage declined from ~7x at YE 2022 to ~6.2x at YE 2023 and is on track to return within Fitch's sensitivities in 2024. The 'BBB' rating reflects Fitch's expectation that DLR will sustain leverage at between 5x-6x through the cycle.

Relatively Resilient Amid Economic Uncertainty: Fitch expects data center fundamentals and contributions from development will support operating cash flow growth through the rating horizon.

Fitch's Global Economic Outlook does not assume a recession in the U.S. in 2024, though weaker economic conditions are expected; however, Fitch views data center demand as relatively defensive since deployments in data centers are typically mission-critical infrastructure. Cash flow predictability benefits from the long lease duration, low churn rate and portfolio diversification across different lease types, geographies, and tenants that together reduce idiosyncratic risks.

Multi-year secular tailwinds such as workflow migration to the cloud are likely to continue, albeit potentially at a decelerated pace if weaker economic conditions persist. Higher energy prices and moderating demand tied to multi-year infrastructure spend could also pose headwinds. Nonetheless, the demand for data center space is expected to expand with the growth of the AI industry.

Secular Tailwinds Balanced by Long-Term Risks: Secular tailwinds such as increased internet utilization and the migration to cloud services support DLR's credit profile. However, data center competition is intense with pricing and market share dynamics constantly evolving. Cloud service providers such as Amazon.com, Inc. (AA-/Stable), Microsoft Corporation (not rated) and Alphabet Inc. (not rated) have been meaningfully scaling their cloud businesses, capturing market share and influence the way enterprises and small business consider their data center use. This represents a long-term competitive risk even though DLR has benefitted from this trend as several of the largest cloud providers are among its top 20 tenants.

Globally Diversified Portfolio: DLR owns, leases and operates a global network of 300+ facilities in 50+ metros across 25+ countries on six continents across the globe with non-U.S. revenues comprising 48% of total revenues at YE 2023. Fitch expects DLR to focus its growth outside of the U.S., which management expects will return higher yields given the mix of 0-1 MW interconnection product type.

Fitch views global operating scale as an important competitive factor for data center REITs. DLR has a strong competitive position through its global network of data centers, which should result in continued growth given high barriers to entry and switching costs, as well as network effects.

Derivation Summary

DLR's ratings reflect its global platform, stable cash flow and liquidity profiles, diversified access to capital, and conservative financial policies. Fitch rates peer Equinix, Inc. (EQIX; BBB+/Stable) higher as a result of lower leverage expectations in the 3.5x-4.5x range relative to DLR, which generally maintains leverage in the 5.0x-6.0x range. Both DLR and EQIX have similar track records in capital access. DLR has a longer relative lease tenor compared with peer Equinix; however, this is balanced by DLR's more concentrated tenant roster and higher exposure to hyperscale tenants.

Fitch rates the IDRs of the parent and its subsidiaries on a consolidated basis, using the weak parent/strong subsidiary approach and open access and control factors, based on the entities operating as a single enterprise with strong legal and operational ties. Although the senior unsecured notes issued and guaranteed by Digital Intrepid Holding B.V. are structurally senior to the remaining senior unsecured debt of DLR with respect to the assets at that entity, Fitch views the structural subordination in this case as not detrimental to the ratings of DLR's remaining senior unsecured debt. Thus, Fitch applies zero notching to all senior unsecured debt issued by DLR and its subsidiaries. No Country Ceiling or operating environment aspects have an impact on the rating.

The two-notch differential between DLR's IDR and preferred stock rating is consistent with Fitch's Corporates Hybrids Treatment and Notching Criteria. The preferred securities are deeply subordinated and have loss-absorption elements that would likely result in poor recoveries in the event of a corporate default. Fitch applies 50% equity credit to the company's perpetual preferred securities given the cumulative nature of coupon deferral. Fitch includes preferred stock when calculating certain metrics.

Key Assumptions

Low single-digit annual same-store NOI growth through 2025, driven by positive cash re-leasing spreads and annual rent escalators, offset in part by growth in operating expenses;

Mid-to-high single-digit revenue growth primarily due to the company's large active development pipeline with a ramp up of new facilities;

Material dispositions in 2024 cover roughly 1/2 of spending on acquisitions and development, based on company guidance. Normalized net investments in acquisitions and development thereafter funded with incremental debt and equity;

Term loans and notes maturing through 2027 are refinanced prior to maturity;

The company has roughly $550 million-750 million of interest expense annually;

Leverage returns below 6x by the end of 2024 and DLR manages leverage such that it remains below 6x over the course of the forecast.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade

Fitch's expectation of REIT leverage (defined as net debt before preferred shares to recurring operating EBITDA after distributions to / from associates and minorities) sustaining below 5x in conjunction with increased mortgage-lending activity in the data-center sector, demonstrating contingent liquidity for the property type;

Fitch's expectation of REIT fixed-charge coverage (recurring operating EBITDA adjusted for straight-line rents and maintenance capex relative to interest and preferred dividends) sustaining above 3x.

Factors that could, individually or collectively, lead to negative rating action/downgrade

Fitch's expectation of REIT leverage (defined as net debt before preferred shares to recurring operating EBITDA after distributions to / from associates and minorities) sustaining above 6x;

Fitch's expectation of REIT fixed-charge coverage (recurring operating EBITDA adjusted for straight-line rents and maintenance capex relative to interest and preferred dividends) sustaining below 2.5x;

Fitch's expectation of UA/UD, at a stressed 9% capitalization rate, sustaining below 2.0x;

Sustained declines in rental rates and same-property net operating income.

Liquidity and Debt Structure

Liquidity Weakened by Active Development: Fitch estimates DLR's sources of liquidity (unrestricted cash, availability under the revolving credit facilities, as well as retained cash flow from operations) are insufficient to cover its uses (debt maturities, committed development expenditures and maintenance capex) through 2025, primarily as a result of the company's high future funding requirements for committed active development.

Although this is the case, Fitch believes that risk is mitigated by the company's access to capital as well as its ability to flex its development pipeline. DLR maintained approximately $2 billion capacity net of letters of credit on its $3.9 billion revolving unsecured facilities at Dec. 31, 2023.

Diversified Access to Capital Markets: DLR has demonstrated strong access to equity and debt-capital markets. DLR has issued bonds in the U.S. dollar-, Euro-, Swiss franc and British pound-denominated debt capital markets, preferred equity and common equity through its at-the-market program. The issuer has access to a range of currencies under its global and Japanese yen-denominated revolving credit facilities, and foreign currency borrowings act as a natural hedge, given its exposure to APAC and EMEA countries.

Data center REIT equities have seen strong performance relative to the REIT indices since the start of the pandemic, and the sector is one of the few that trades at a premium to underlying value today. As well, data center REITs have also generated additional capital through Commercial Mortgage-Backed Securities transactions.

In recent years, DLR has entered into several joint ventures with sizable domestic and foreign partners, including Brookfield Infrastructure Partners L.P., Mapletree Investments Pte Ltd., Mitsubishi Corporation, Blackstone, TPG Real Estate, and GI Partners. Fitch notes that a moderate amount of joint venture ownership can help diversify DLR's capital sources, and establish and maintain relationships with deep-pocketed through-the-cycle capital providers.

Additionally, Fitch expects DLR will continue to sell stabilized assets into Digital Core REIT (SGX: DCRU), a standalone publicly traded vehicle on the Singapore Exchange that is sponsored, managed and 35% owned by DLR.

Improving Secured Mortgage Access: DLR owns the vast majority of its data center assets, which is a credit positive that provides some asset-level protection in a downturn. DLR's ratings are balanced, however, by its data center portfolio focus. The availability of mortgage capital for data centers is improving, but Fitch believes contingent liquidity is still weaker relative to other commercial real estate property types during periods of potential financial stress.

Below-Average Net UA/UD Coverage: Fitch estimates DLR's unencumbered assets would cover net unsecured debt (UA/ UD) by roughly 1.9x assuming a 9% stressed cap rate as of Dec. 31, 2023. Investment-grade REITs rated by Fitch typically have UA/UD ratios around 2.0x indicating DLR has a slightly below-average amount of unencumbered assets relative to unsecured borrowings.

Issuer Profile

Digital Realty Trust, Inc. (NYSE: DLR) owns, acquires, develops and operates both hyperscale and colocation data centers for domestic and international customers across a variety of industry verticals ranging from cloud and information technology services, communications, social networking, financial services, manufacturing, energy, health care, and consumer products.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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