While 2023 is expected to be another record year for data center investment, Allied Properties (CA:AP.UN, US:APYRF) announced on June 21 that it would sell its portfolio of data centers in downtown Toronto for $1.35 billion. The announcement was the real estate investment trust’s (REIT) second big announcement in June. (All figures in Canadian dollars.)

The sale follows a June 12 announcement that the REIT had converted from a “closed-end” trust to an “open-end” trust. The move was made to align itself with its Canadian REIT peers. The move enables a slight reduction in its capital cost, which should lead to a higher valuation.

However, there is no question that the sale of data centers is the more important news. The owner of urban offices in Canada’s major cities has seen its shares fall by nearly 15% in 2023 and 47% over the past five years.

The REIT currently pays a monthly distribution of $0.15 a unit; the next ex-date is June 29. On an annualized basis, its $1.80 distribution yields a high 8.2%. AP.UN stock is down 16.6% so far in 2023. That compares with a 4.8% decline in BMO Equal Weight REITs Index ETF (CA:ZRE) in the same period.

Smaller’s Better

AI, 5G and hybrid work are fueling the rise of “edge computing,” real estate broker JLL said in a June 15 publication that forecast 32% growth in demand this year and next for smaller data centers.

“Hyperscale centers are usually located in cities and can typically house 10,000 racks with a capacity in excess of 80 megawatts (MW),” the broker noted. “Edge data centers by comparison, have a smaller capacity between 500 kilowatts to 2 MW and, as the name suggests, are located on the outer edge of networks.”

As for Allied’s Toronto data center sale, the question is whether the reallocation of proceeds will be enough to get investors to buy its stock amid a struggling office category in Canadian commercial real estate.

As of March 31, Allied had 199 rental properties with 14.4 million square feet of space for lease valued at $8.3 billion. Approximately 5.0 million square feet of the space is in Toronto, with 6.2 million in Montreal, accounting for nearly 78% overall. Allied’s occupancy rates in both cities are higher than the overall market for office space.

Fast Sale

The REIT first announced that it was exploring the sale of its data centers in November 2022. At the time of the announcement, it said it evaluated strategic opportunities for these assets. Two months later, it formally put them up for sale in mid-January.

“Our principal motivation here is two-fold,” said Michael Emory, president & CEO. “First, we want to reaffirm our mission and pursue it over the next few years with low-cost capital. Second, we want to supercharge our balance sheet and reduce our dependence on the capital markets going forward.”

The sale of its data centers enables Allied to focus solely on its urban workspaces. In addition, the debt reduction brings its balance sheet debt metrics in line with the REIT’s targets.

It’s addition by subtraction.

Allied is selling the assets to KDDI Corp. (JP:9433), a Japanese company that owns data centers in Asia, the U.S., Europe, and Canada. The sale’s expected to close by September 2023.

“With global data-centre operating capability, KDDI is an ideal successor owner-operator for our UDC portfolio,” Emory said in Allied’s press release announcing the sale.

Cost of Capital Cut

The sale price of $1.35 billion is said to be $118 million higher than its net asset value. Allied will use $1 billion to pay down its debt. As of March 31, it had $4.34 billion. The repayment reduces the outstanding balance by approximately 23% and its total indebtedness ratio from 36.5% to an expected 32.7% by the end of the fourth quarter.

It also anticipates that its net debt by the end of 2023 should be 8.0x its annualized adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) with an interest-coverage ratio of 3.0x, up from 2.8x at the end of March.

The REIT expects that the sale will provide it with greater financial flexibility.

“The sale proceeds will enable us to fund near-term growth, primarily in the form of upgrade and development completions, while maintaining unprecedented levels of liquidity and targeted debt-metrics,” Emory said.

“In the longer-term, we plan to take advantage of a broader range of funding opportunities than we have in the past. Regardless of how we fund growth going forward, we’ll remain fully committed to our distribution program.”

This article originally appeared on Fintel

Thank you for reading! Have some feedback for us?
Contact the 24/7 Wall St. editorial team.