Real Estate Investment Trusts, or REITs, are often favorites of dividend growth investors due to their high yields. By law, REITs must distribute at least 90% of their taxable income in the form of dividends to shareholders. While many are familiar with REITs that specialize in retail space, medical office buildings or assisted living centers, one under-owned area of real estate is that of the information technology space. And one company that investors should know in this space is Digital Realty Trust (DLR).

Company Overview

DLR purchases and develops properties for technological use. The company’s properties are made up of data centers used for cloud computing, technology manufacturing sites and Internet gateway data centers that are used to transmit data among major metro areas. 

DLR leases these facilities to companies needing this very advanced technology. DLR has more than 200 properties around the world, with more than 150 of them located in the United States.

Recent Earnings Release and Bullish Thesis

For REITs, Funds From Operation, or FFO, is a better measure of profitability and cash flow then the traditional earnings per share metric that Wall Street usually uses to values stocks. Depreciation costs weigh on earnings and REITs often have high levels of depreciation. For this reason, DLR and other REITs are often valued on their price to FFO multiple. 

DLR released 1^st quarter earnings back on April 26.  DLR reported FFO of $1.63 per share during the quarter, beating analysts’ estimates by $0.06. This was a 7.2% increase from the first quarter of 2017. Revenue grew 35.2% to $744.37 million, topping expectations by $1.05 million.  DLR has seen quarterly revenues almost double since the beginning of 2014. The company had occupancy rates above 90% for the quarter.

The REIT increased the low end of its FFO/share guidance for 2018 to $6.50-$6.60 from $6.45-$6.60.  Based off of the update guidance and Friday’s closing price of $116, DLR trades with a price to FFO ratio of 17.7. Over the last ten years, the price to FFO multiple is 15.  Shares are overvalued relative to their historical valuation, but that doesn’t mean DLR doesn’t have growth prospects.

The demand for cloud computing services has led to higher demand for data centers. DLR is in a prime position to capitalize on that demand. For example, In April, DLR partnered with Google (GOOGL) to launch support for a new service that allows corporations access to several different cloud platforms. This deal is an example of DLR’s ability to build strong partnerships with large tech firms while meeting the need for data centers.  

DLR has been highly active on the acquisition front in order to grow as well.  In 2017, the REIT purchased DuPont Fabros Technology.  Like DLR, Dupont Fabros was a technoogy REIT that leases properties to some of the largest tech companies in the world, like Microsoft (MSFT) and Facebook (FB). Once leased to these tech companies, they are free to build their own data centers within the properties.

In addition, DLR has proven itself to be fairly recession proof. In 2009, in the depths of the last recession, the REIT actually saw 12% growth in FFO per share. The REIT has seen FFO improve every year for the last decade. This is even more impressive when you factor in that DLR has seen a share count increase in every single year over the last ten years.

The Dividend

From 2008 to 2017, DLR grew its dividend at a compound average growth rate of 11.4% per year. On March 2, it was announced that shareholders would receive an 8.6% dividend increase. While DLR’s current yield of 3.5% can be considered low in the REIT sector, it is still higher than the yield of the S&P 500 (1.8%) and the yield of the 10-year Treasury Bond (2.9%). Even better, DLR is expected to pay out just 61.6% of FFO in the form of dividends in 2018. This leaves DLR plenty of room to increase its dividend going forward.

Conclusion

While Digital Realty Trust is overvalued based off of its historical price to FFO multiple, the stock is positioned for growth in future years. High demand for data centers makes DLR’s properties very attractive. Add in a generous dividend yield and a low payout ratio and DLR is one REIT dividend investors should consider for purchase.