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Maintaining Digital Reality - A Comparison Of Recurring Property Costs At DLR & COR

|Includes:COR, Digital Realty Trust, Inc. (DLR)

This article is a follow on to my prior post on AFFO and payout ratios at DLR and Corsite (NYSE:COR).

For this data analysis, the following concepts will be important to consider:

1) Maintenance and Property Operating costs show up as expense on the income statement. Accordingly, they are reflected in both FFO and AFFO. For the Data Center REITs, in addition to maintenance/repairs costs, this income statement line item contains utilities expenses (electrical, water, trash, heating/cooling) paid by the property as well as network charges paid to third party providers. Electricity is the key item driving these costs and the Data Center's ability to pass-through electrical costs to customers has a significant impact on the profitability of the business model. Additionally, 2013 Maintenance and Property Operating costs for DLR have been adjusted to exclude the $10M straight line rent error (as that amount was included in that line item in Q3 2013) for comparative purposes.

2) Real estate taxes and property insurance expenses appear on the income statement and thus in FFO and AFFO. A significant portion of these costs are passed through and collected as part of tenant reimbursements.

3) Recurring Capex charges reflect costs that are necessary to upkeep and maintain the property on a recurring basis and would have been expensed as maintenance/property operating costs but for the fact that they extend the useful life of assets. This cost pool does not include "non-periodic enhancement and improvement capex" (i.e. upgrades). For DLR, in 2013, recurring capex includes approximately $2M of capitalized repairs under $10K as a result of their accounting method change earlier this year (IMO, a rather immaterial adjustment).

4) Tenant reimbursements & Power revenue are gross revenue accounts on the income statement and reflect amounts collected from tenants for the previously stated cost items (maintenance and property operating expense, real estate taxes and property insurance expense, and recurring capital expenditures). As stated before, the most significant recurring cost to recover from tenants is electricity. For DLR electricity cost recoveries show up in the "tenant reimbursements" revenue account, whereas for Corsite, electricity is largely sub-metered ("breakered") to each tenant and collected as "power revenue".

5) In order to compare the costs of delivering "Digital Reality" to the tenants on a recurring basis, I am netting these recurring costs with the tenant cost recovery accounts to come up with "net recurring property charges". I then convert these amounts for each company into a per diluted share amount to make comparisons possible.

As an aside, although I don't include these amounts in the data analysis, non-periodic improvement and enhancement capex are costs incurred to upgrade the properties, but are not required to maintain/repair existing assets, so they are not considered part of AFFO. Enhancements and improvements are typically financed with debt and or equity, instead of operating cash. The important concept to consider with this pool of "non-periodic" costs is that in order to be a cutting-edge Data Center REIT, the business model requires constant injections of new capital to finance these non-periodic upgrades and enhancements.

As stated in the prior post, as I only have 2013 data through Q3, I've used estimates based on guidance from each company for Q4 2013 where I could, and used the Q3 amount for Q4 where guidance did not have sufficient detail.

Additionally, before getting to the data, I want to stress that I take no responsibility for your investment decisions and that you must perform your own due diligence. This data and any analysis are for informational purposes only and are intended to promote financial literacy.

Sources are the same as the prior post on AFFO. Amounts (other than per share and %'s) are in '000's.

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Take-aways:

1) DLR's net recurring property charges have been growing significantly at 24% from 2011 to 2012 and then another 17.5% from 2012 to 2013, whereas COR's net charges have declined significantly at ~ -16% from 2011 to 2012 and have essentially remained constant at ~1% growth from 2012 to 2013.

2) DLR's net recurring property charges have increased at a much faster pace than their overall FFO and AFFO growth. Whereas COR's net charges have essentially remained flat while overall FFO and AFFO have been growing at a relatively high pace.

After thinking about these relationships in the context of each company's business, I've come to realize that DLR is paying for higher occupancy rates 91-92% by absorbing a lot of the costs that Corsite is passing through to tenants (Corsite's occupancy rate is 80-81%). However, higher occupancy is not necessarily more desirable from a shareholder perspective if the lower occupancy model is more profitable. For me, this relationship helps to explain DLR's decision to move into the middle market and compete for Corsite's bread and butter because COR's business seems to make a lot more sense financially (low recurring costs - high growth) than DLR's fully-loaded large-tenant model (high recurring costs - low growth).

Best of luck on your investments.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in COR over the next 72 hours.

Additional disclosure: I have no affiliation with either company and I wrote this post myself. I am long DLR-E preferred stock.

Stocks: DLR, COR