Digital Realty Earnings: Weaker Leasing, but Stellar Pricing and Connectivity Shift in Full Force

Digital Realty DLR had a good first quarter. Overall leasing was down, but leasing is often choppy, so we wouldn’t overemphasize a single quarter’s result. More important to us, pricing was the strongest in years, and Digital’s smaller co-location and interconnectivity deployments are currently the strongest parts of its business. We think those co-location and interconnection leases are more profitable and contribute to a data center’s competitive advantages, supporting our rationale for a positive network effect moat trend rating for this narrow-moat firm. We are raising our fair value estimate to $135 per share from $133 and believe the current stock price provides a good entry point.

Digital signed only $84 million in annual new lease revenue during the quarter, its worst result since it closed its Interxion acquisition in early 2020. However, the shortfall was due almost entirely to low amounts of scale leasing, which represent Digital’s biggest deployments. We expect scale leasing to pick up throughout the remainder of this year, but an inability to bring much new supply in Virginia, Digital’s biggest scale market, may keep annual scale bookings lower for the next couple of years than they’ve been more recently. Issues with the power company there are keeping supply tight throughout the industry, which is benefiting pricing.

Pricing on renewal leases were by far the best they’ve been in years—likely since before Digital bought DuPont Fabros in 2017, an acquisition that landed Digital many leases that were priced above current market rates. Pricing was strong across the portfolio, with cash rates on the co-location-type spaces below 1 megawatt rising 4.6% and rates on the scale spaces above 1 megawatt rising 4.4%. Digital also said nearly half of leases now have annual escalators tied to inflation rather than fixed rates. With supply tight and churn low (about 1%), we expect strong pricing power to continue.