Realty Income (O -0.32%) built its business around paying a dependable and steadily rising dividend. The real estate investment trust (REIT) has paid 641 consecutive monthly dividends throughout its history. It has increased its payout a phenomenal 122 times since its public market listing in 1994.
That dividend (which currently yields 6.2%) should continue its steady rise. The REIT’s ability to expand into new property verticals with long growth runways is a big factor driving that view. It recently made its first investment in the data center sector, representing a massive $1 trillion investment opportunity over the next decade.
The first step in building a new growth platform
Realty Income is forming a development joint venture (JV) with data center REIT Digital Realty (DLR -0.85%). The JV will support the development of two build-to-suit data centers in Northern Virginia that are already 100% pre-leased to a large-scale corporate tenant under a 10-year term. Realty Income will invest $200 million to acquire an 80% interest in the JV, while Digital Realty will retain the other 20%.
The partners will each fund their proportional share of the remaining $150 million cost to finish the first development phase. Digital Realty should complete construction on the two data centers in the middle of next year. The $400 million project will initially have 16 megawatts (MWs) of capacity.
Realty Income expects this investment to generate an attractive return. It will earn a strong 6.9% cash yield on its investment once the lease commences in the middle of next year. That will give it more cash flow to pay dividends.
In addition, this investment has two embedded growth drivers. The lease contains a 2% annual rental-rate escalator. Meanwhile, the tenant has the option to expand the capacity up to 48 MWs during the initial lease term. That expansion option could increase the total investment to $800 million. Those growth drivers would further boost its cash flow and ability to continue growing the dividend.
Realty Income’s CEO Sumit Roy commented on the partnership in the press release revealing the JV. He stated:
One of Realty Income’s core strategies is to partner with companies that are leaders in their respective industries. To that end, for our initial investment in the net lease data center vertical, we are pleased to partner with Digital Realty, the largest provider of cloud- and carrier-neutral data centers whose global platform is well respected in the industry.
Plugging into the data center megatrend
The JV with Digital Realty is likely the first of many data center investments for Realty Income. Leading global-infrastructure investor Brookfield Infrastructure highlighted the tremendous investment opportunity in the sector at its recent investor day. Felix Chan, one of the speakers at Brookfield’s Investor Day, stated:
We’re in a once-in-a-generation investment cycle for data centers at the moment. We estimate that we will need over a trillion dollars over the next 10 years to invest in data centers to ensure that there is sufficient infrastructure for the growth in data consumption. In terms of megawatt capacity over the next three years, we estimate that an additional six gigawatts of capacity will be required to meet data demand.
Many data center operators have more opportunities than they can afford to develop. That’s leading them to partner with other companies that have available capital to deploy.
Digital Realty is a prime example. The leading data center REIT has a robust development pipeline. However, it lacks investment capacity, partly because its heavy investments in recent years have weighed on its balance sheet. That has led the company to seek new ways to help fund data center developments. For example, it partnered with Brookfield Infrastructure and Reliance Industries to develop new data centers in India. It has also sold several stabilized data centers to private equity funds, freeing up that capital to invest in new developments.
Data center operators will continue to need capital to fund new developments. That should open the doors to additional opportunities for Realty Income to acquire stabilized net-leased facilities or participate in development projects. Those future investments will help grow its cash flow, giving Realty Income more power to increase its dividend.
Capitalizing on an enormous opportunity
Realty Income is making its first investment in the data center sector. That space could become a major growth driver for the REIT, given the amount of capacity needed over the next decade. It should enhance its ability to continue growing its attractive monthly dividend, making it an even better long-term investment opportunity.
Matthew DiLallo has positions in Brookfield Infrastructure, Brookfield Infrastructure Partners, Digital Realty Trust, and Realty Income. The Motley Fool has positions in and recommends Digital Realty Trust and Realty Income. The Motley Fool recommends Brookfield Infrastructure Partners. The Motley Fool has a disclosure policy.