Prediction: This Data Center REIT Could Be a Top Dividend Play in the AI Era

Artificial intelligence (AI) stocks and real estate investment trusts (REITs) generally attract different types of investors. Leading tech stocks like Nvidia are more apt to appeal to growth-oriented investors, while REITs -- which purchase properties, rent them out, and distribute the lion's share of their income through dividends -- are more favored by income investors.

But instead of choosing between the AI industry's growth potential and the REIT sector's income, it's possible to invest in both markets through data center REITs, which buy data centers and rent space in them out to large cloud infrastructure, AI companies, and others.

Image source: Getty Images.

REITs enjoy a lower tax rate than most other companies, but they're obligated to pay out at least 90% of their pre-tax income each year in dividends. That makes them an obvious choice for income-focused investors. Data center REITs' share prices might not rise as rapidly as other types of companies connected to the AI megatrend, nor generate higher yields than REITs in other industries, but they can offer a good balance of growth and income. One of the best plays in this niche is Digital Realty Trust (NYSE: DLR).

What does Digital Realty Trust do?

Digital Realty Trust operates more than 300 data centers across more than 50 metropolitan areas. It serves more than 5,000 customers, including over half of the Fortune 500. Its top clients include IBM, Oracle, and Meta Platforms.

Digital Realty's health can be gauged by its growth in total data centers, its rentable square feet, year-end occupancy rates, and adjusted funds from operations (AFFO) per share -- the metric that most REITs prefer to use to gauge their profitability and ability to cover their dividend payments. So as long as a REIT's AFFO payout ratio stays below 100%, its dividends will remain sustainable. Here's how it fared over the past four years as the AI market expanded, but the macro headwinds intensified.

Data source: Digital Realty.

In 2022, the size of Digital Realty's data center portfolio peaked as its occupancy rates improved. But in 2023 and 2024, it sold some of its "non-core" data centers (which were older and smaller, with limited growth opportunities) and reduced its ownership in some of its other data centers through strategic joint ventures. That strategy streamlined its spending and allowed it to focus on expanding its higher-growth hyperscale data centers in its core metro clusters.

But that slimming down of its data center business -- along with its higher interest rate expenses, growth in electricity and construction expenses, and currency headwinds from a strong U.S. dollar -- temporarily reduced its AFFO per share and led management to pause its annual dividend hikes.

Yet brighter days might be ahead as the macroeconomic environment improves. For 2025, management expects Digital Realty's constant-currency core FFO (which excludes the costs of one-time divestments and joint ventures, as well as foreign exchange rate impacts) to rise by 6% to 7% to between $7.10 per share and $7.20 per share. It also expects its year-end occupancy rate to improve by 100 to 200 basis points.

Why Digital Realty could be a great AI dividend play

Shares were recently trading at around $175. At that level, Digital Realty's dividend has a decent 2.8% yield. That's lower than the 10-year U.S. Treasury's 4% yield, but that gap should narrow as interest rates decline. The secular expansions of the cloud computing and AI markets should also boost its AFFO per share and give management more room to raise dividends, and the stock still looks reasonably valued at about 24 times this year's core FFO estimate. By comparison, its rival Equinix (NASDAQ: EQIX) trades at 22 times this year's AFFO estimate, but has a lower 2.3% yield.

So if you're looking for a balanced way to profit from the growth of the AI market that also distributes steady income, Digital Realty checks all the right boxes. Declining interest rates should also make its dividend more appealing, reduce the macro headwinds for its top customers, and make it cheaper for the REIT to expand its data center portfolio again.

Leo Sun has positions in Meta Platforms. The Motley Fool has positions in and recommends Digital Realty Trust, Equinix, International Business Machines, Meta Platforms, Nvidia, and Oracle. The Motley Fool has a disclosure policy.