DBRS Morningstar Assigns Provisional Ratings to DC Commercial Mortgage Trust 2023-DC

DBRS, Inc. (DBRS Morningstar) assigned provisional ratings to the following classes of Commercial Mortgage Pass-Through Certificates, Series 2023-DC (the Certificates) to be issued by DC Commercial Mortgage Trust 2023-DC (DC 2023-DC):

-- Class A at AAA (sf)
-- Class X at AA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (low) (sf)
-- Class HRR at BB (sf)

All trends are Stable.

DC 2023-DC is a single asset/single-borrower transaction collateralized by the borrower’s fee-simple interest in two data center properties totaling three buildings in Ashburn, Virginia. DBRS Morningstar generally takes a positive view of the credit profile of the overall transaction based on the portfolio’s favorable market position, affordable power rates, desirable efficiency metrics, and strong tenancy profile. The loan is unclosed by expected to close on or before August 30, 2023 and terms of the loan are subject to change.

Data centers, while having existed in one form or another for many years, have become a key component in the modern global technology industry. The advent of cloud computing, streaming media, file storage, and artificial intelligence applications has increased the need for these facilities over the last 10 years in order to manage, store, and transmit data globally. While previous incarnations of data centers were often constructed in existing buildings that were converted, the needs of the market require purpose-built facilities that are engineered for this single use.

From the standpoint of the physical plants, the data center assets are heavily powered with more than 104 megawatts (MW) of critical IT load and feature N+2 redundancy for all building systems. DBRS Morningstar views the data center collateral as strong assets with strong critical infrastructure, including power and redundancy, built to accommodate the technology needs not only of today, but also well into the future. Digital Realty, 20% owner and the operator of the portfolio, currently owns and operates more than 300 data center properties across 28 countries.

Data center operators have historically benefited from high barriers to entry because of the complexity of their operations along with the specialized knowledge required to operate the facilities to extraordinarily demanding uptime and reliability standards. Furthermore, the high upfront capital costs and necessary power infrastructure also make speculative development more difficult than with other property types. Moreover, local power provider Dominion Energy announced in July 2022 that it cannot allocate additional power to new data center developments in Northern Virginia, essentially delaying new data center development through 2026.

The portfolio’s Issuer underwritten (UW) rent for data center space is approximately 17.9% below the sponsor’s market rent estimates and recent leasing data. This represents an opportunity for the sponsor to push rolling and expiring leases to a higher rental rate that is closer to the market rent. Leases signed since Q4 2022 at both the subject property and in Digital Realty’s Northern Virginia portfolio exhibit an average rent of $150 per kilowatt (kW) per month, which is significantly higher than the Issuer UW rent of $95.88 per kW per month. According to market data listed in the term sheet, the Ashburn submarket generally commands rents between 10% and 15% above the remaining Northern Virginia market.

Data center operators benefit from strong clustering and network effects attributable to the complex IT environments of their tenants. For various reasons, larger tenants strongly prefer to scale within existing environments rather than add capacity at a facility with a different provider.

The assets are in Ashburn, Virginia, which is part of the greater Northern Virginia market known as Data Center Alley. Northern Virginia is the largest data center market in the world and is supported by some of the most favorable wholesale power costs and tax rates in the country. Ashburn’s wholesale power costs are approximately $0.05 per kilowatt hour (kWh), which compares favorably with other nearby markets where power costs can be higher, such as Pennsylvania, New Jersey, and Manhattan, which exhibit power costs of $0.0771/kWh, $0.1105/kWh, and $0.13/kWh, respectively. The properties within the portfolio—named ACC5, ACC6, and ACC7—exhibit power utilization efficiency (PUE) ratios of 1.48, 1.47, and 1.20, respectively, which indicates a relatively efficient delivery of power to critical IT infrastructure. However, the properties have design PUE ratios of 1.28, 1.28, and 1.15, respectively. Typical PUE ratios range from 1.2 to 3.0 and, according to a third-party market report outlined in the Term Sheet, average annual PUE across all data centers in the United States is 1.80.

The cross-collateralized portfolio benefits from relatively granular tenancy and favorable industry diversification. The portfolio also benefits from the tenancy of numerous cloud and IT tenants and hosts service provider tenants whose significant power consumption and complex needs are projected to only grow over time. Additionally, approximately 58.7% of the DBRS Morningstar in-place base rent is attributable to investment-grade tenants across the portfolio, which is a highly favorable ratio.

The $990.0 million mortgage loan represents an 84.33% loan-to-value ratio on the DBRS Morningstar value of $1.174 billion, which is relatively modest compared with more fully leveraged single-asset/single-borrower transactions.

Digital Realty is an experienced data center operator with a portfolio of more than 300 data centers in 28 countries on six continents. The company has established relationships with significant power users across various industries. Furthermore, the company has committed to improving the sustainability of their operation with approximately 62% of their global power provided through a renewable source. The sponsor on the transaction is a joint venture between Digital Realty and TPG, a global private equity firm founded in 2009 with approximately $139.0 billion in assets under management (AUM) as of the end of 2022. The experienced institutional sponsorship of TPG complements Digital Realty’s experience in operating the data center assets. TPG has a dedicated team focused on real estate with more than $19 billion in AUM.

ACC5 and ACC7 are LEED Gold certified and exhibit strong design PUE ratios of 1.28 and 1.15, respectively, while ACC6 is LEED Silver certified and exhibits a design PUE ratio of 1.28. All the data center buildings in the portfolio were constructed with N+2 redundancy, which will allow for two failures of any system. N+2 redundancy also allows for more flexibility for repair and maintenance of the various mechanical systems at the property.

Data center properties require specialized operational knowledge and expertise in order to operate to extremely high uptime and reliability standards set forth in various service-level agreements with tenants. Therefore, the pool of potential buyers may be more limited than for other asset types, such as warehouse or distribution properties. Furthermore, a substantial component of the portfolio’s value is dependent on Digital Realty’s tenant roster and extensive industry relationships and technical expertise. However, Digital Realty has significant experience in the operation and management of data centers, especially in Northern Virginia where it has significant experience and manages 16 data center properties. The loan documents require that any replacement manager meet certain qualifications, including, but not limited to, at least five years’ experience in the management of at least five data centers totaling 1.0 million square feet (sf), or be one of the pre-approved managers outlined in the offering documents.

DBRS Morningstar views data center properties as significantly more capital intensive beyond the identifiable shell building repairs captured by a typical engineering report. Data center properties typically have dedicated on-site utility substations, complex closed loop and evaporative cooling systems, and substantial uninterruptible power supply and backup generator systems that must be proactively maintained and replaced to ensure the highest level of uptime and reliability. The property condition report estimated $1.24 per sf (psf) in ongoing capital expenditure (capex) needs across the portfolio. DBRS Morningstar assumed higher ongoing capex requirements of $4.00 per kW per month in its concluded cash flow to reflect the higher capital-intensive needs of the properties.

The loan agreement permits the borrower to release individual properties across the portfolio pursuant to a release premium of 110% of the allocated loan amount. DBRS Morningstar considers 110% to be weaker than a generally credit-neutral standard of 115%. As a result, DBRS Morningstar applied a penalty to the sizing hurdles to account for this release structure. As it relates to the release of individual properties, ACC5 and ACC6 are on the same tax parcel and must be released together. ACC7 is on its own tax parcel and can be released on its own.

DBRS Morningstar’s credit rating on the Certificates addresses the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations are listed at the end of this Press Release.

DBRS Morningstar’s credit rating does not address non-payment risk associated with contractual payment obligations contemplated in the applicable transaction document(s) that are not financial obligations (for example, Yield Maintenance Premium).

DBRS Morningstar’s long-term credit ratings provide opinions on risk of default. DBRS Morningstar considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/416784 (July 4, 2023).

Class X is an interest-only (IO) certificate that references a single rated tranche or multiple rated tranches. The IO rating mirrors the lowest-rated applicable reference obligation tranche adjusted upward by one notch if senior in the waterfall.

All credit ratings are subject to surveillance, which could result in credit ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is North American Single-Asset/Single-Borrower Ratings Methodology (February 23, 2023; https://www.dbrsmorningstar.com/research/410191).

Other methodologies referenced in this transaction are listed at the end of this press release.

With regard to due diligence services, DBRS Morningstar was provided with the Form ABS Due Diligence-15E (Form-15E), which contains a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the credit ratings referenced herein.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the credit rating process.

DBRS, Inc.
140 Broadway, 43rd Floor
New York, NY 10005 USA
Tel. +1 212 806-3277

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

Legal Criteria for U.S. Structured Finance (December 7, 2022; https://www.dbrsmorningstar.com/research/407008)

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 12, 2022; https://www.dbrsmorningstar.com/research/402646)

North American Commercial Mortgage Servicer Rankings (September 8, 2022; https://www.dbrsmorningstar.com/research/402499)

Rating North American CMBS Interest-Only Certificates (December 19, 2022; https://www.dbrsmorningstar.com/research/407577)

For more information on the credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

Financial Obligations of the issuer are listed as follows:

-- Class A Principal Amount
-- Class A Interest Distribution Amount
-- Class X Interest Distribution Amount
-- Class B Principal Amount
-- Class B Interest Distribution Amount
-- Class C Principal Amount
-- Class C Interest Distribution Amount
-- Class D Principal Amount
-- Class D Interest Distribution Amount
-- Class HRR Principal Amount
-- Class HRR Interest Distribution Amount