Digital Realty's Growth Constraints: Power, Scale, and the AI Infrastructure Shift

The core investment tension for Digital Realty is a fundamental misalignment between where the largest AI infrastructure dollars are flowing and where the company is positioned to capture them. The era of hyper-scale AI projects is defined by sheer scale and a relentless pursuit of speed. Deals are now routinely exceeding 1GW, and customers are prioritizing emerging data center markets for faster deployment, a shift that directly bypasses Digital Realty's primary-market footprint. This migration creates a clear "poor fit" for the company's development pipeline, which is constrained by both scale and location.

The mismatch is most acute in the power domain. In key markets like Santa Clara, California, the company faces a severe bottleneck: two large data centers remain completed but unpowered due to local utility constraints that are expected to delay energization for several years. This is not an isolated incident but a symptom of a broader structural challenge. As AI workloads demand unprecedented power densities, the availability of grid capacity is becoming the primary gatekeeper for new development. For a company whose growth depends on executing a development schedule, this power constraint directly limits its capacity to compete for the largest deals.

The result is a growth trajectory that may lag behind the sector's peak momentum. Analysts note that the company has lagged in capturing AI-driven demand, with the largest 2025 deals favoring markets outside its core. This trend is expected to continue, creating downside risk to near-term leasing forecasts. While Digital Realty's fundamentals remain strong-with a record demand pipeline and resilient execution-the structural mismatch means its growth will be more incremental and less explosive than that of peers who have positioned themselves in the emerging, high-speed corridors of the AI infrastructure build-out. The company's focus on primary markets, once a strength, is now a potential liability in a race where location and speed to market are paramount.

Financial Impact: Resilience in a Constrained Environment

The financial picture for Digital Realty presents a clear duality: robust operational resilience masking a decelerating growth trajectory. The company's fundamentals remain solid, but the constraints from the AI infrastructure shift are beginning to show in its quarterly metrics.

On the surface, the results are strong. The company posted a record $1.87 Core FFO per share in Q2 2025, a 13% year-over-year jump that beat expectations. This reflects the underlying strength of its existing portfolio and leasing activity. The momentum carried into the third quarter, with Core FFO per share rising to $1.89. Yet this increase is a step down from the prior quarter's growth rate, signaling a potential plateau. The deceleration is a subtle but important signal that the easy growth from the previous cycle is winding down.

This resilience is underpinned by a massive backlog that provides visibility. At the end of Q3, the company reported a $852 million backlog of annualized GAAP base rent. This is a critical buffer, representing future revenue that is already committed. However, the backlog's utility is tempered by the current market's conversion dynamics. The weighted-average lag between a new lease being signed and its commencement date is eight months. In a market where grid constraints are delaying the energization of completed data centers by years, this lag becomes a significant vulnerability. The backlog provides visibility, but it does not guarantee timely cash flow if the physical delivery of power is blocked.

The bottom line is that Digital Realty is executing well within its current model, but the model itself is facing structural headwinds. The company's ability to convert its record bookings into revenue is being stretched by the very power constraints that limit its development pipeline. This creates a financial setup where top-line growth is likely to remain muted in the near term, even as the company leverages its balance sheet strength and strategic fund structures to position for a longer-term AI cycle. The record FFO per share is a testament to operational discipline, but the deceleration and the backlog's inherent delay risk highlight the growth constraints that define the current investment thesis.

Valuation and Market Sentiment: The Bond Proxy Effect

The market's verdict on Digital Realty is now a study in stark contrast. While the company's fundamentals remain robust, its valuation is being capped by a growing perception that it is a slow-growth, high-quality operator rather than a pure-play AI infrastructure winner. This shift in narrative is crystallizing in sharply divided analyst sentiment and a clear re-rating of its multiples.

On one side, optimism persists. Wolfe Research recently upgraded the stock to Outperform, citing its status as a "stable growth company with a predictable business model" and highlighting its resilience to macroeconomic softness. Other analysts have raised price targets, pointing to a record demand pipeline and solid execution as evidence of underlying strength. This bullish view is reflected in a slightly higher fair value estimate, nudged to about $199.22 per share as confidence in the durability of future cash flows improves.

On the other side, the bear case is gaining ground. Bank of America delivered a decisive downbeat, cutting its rating to Neutral and slashing its price target to $170 from $210. The rationale is direct: growth constraints are limiting multiple expansion. BofA's analysis confirms the structural mismatch identified earlier, noting that the company's development pipeline is a "poor fit" for current AI demand. The key takeaway is that the stock is being viewed increasingly as a "bond proxy" rather than a direct beneficiary of the AI buildout. This perception, which BofA says will keep the broader data center group out of favor in 2026, inherently caps valuation upside.

The tension is clear. The stock is consolidating around $152, caught between these competing views. The upgrade to Outperform signals that some see value in its stability and cash flow predictability. Yet the downgrade to Neutral, with a price target cut based on a lower 2026 core FFO multiple, reflects a market that is unwilling to pay a premium for growth that is perceived to be constrained. For investors, this creates a binary setup. The "bond proxy" label means the stock may offer a reliable yield and downside protection, but it also means it will likely trade in a range, with limited explosive upside, until the company can demonstrate a credible path to capturing the scale and speed of the next AI infrastructure cycle. The valuation now seems to be pricing in the growth constraints, not the potential.

Catalysts and Risks: The Path to Re-rating or Further Discount

The coming months will test whether Digital Realty's growth constraint thesis holds or breaks. The primary catalyst is the Q4 2025 earnings release scheduled for February 5, 2026. Investors will scrutinize the company's ability to convert its massive backlog into tangible leasing execution. The key metric will be the pace at which the $852 million backlog of annualized GAAP base rent is being converted into revenue, particularly given the eight-month lag between signing and commencement. A strong conversion rate would signal operational resilience and provide a buffer against the structural headwinds. A weak one, however, would validate the bear case that the company's primary-market focus is leaving it behind in the AI build-out.

The central risk is that AI projects continue to bypass its footprint, leading to further downgrades and a failure to re-rate from the "bond proxy" status. Analysts have already noted that the largest 2025 deals favored emerging data center markets outside its footprint. If this trend continues into 2026, with projects exceeding 1GW prioritizing speed to market in new corridors, Digital Realty's ability to capture the next wave of demand will be severely limited. This would likely trigger a reassessment of its growth premium, keeping its valuation capped by historically negative REIT sentiment.

The company's path to adaptation hinges on its capital deployment. It possesses a formidable $9 billion development pipeline and a newly launched $3 billion U.S. Hyperscale Fund. The critical question is how effectively it can leverage these resources to shift its focus toward the emerging, high-speed markets that are now the epicenter of AI infrastructure. Success would demonstrate strategic agility and could eventually support a re-rating. Failure to meaningfully redirect its capital would confirm the "poor fit" narrative, leaving the stock to trade on its stable cash flows without the multiple expansion that a pure-play AI winner commands.

The bottom line is that the coming earnings report is a litmus test. It will reveal whether the company's operational strength can offset its strategic constraints in the near term. For a re-rating to occur, Digital Realty must not only meet its financial targets but also provide a credible, capital-intensive plan to bridge the gap between its existing footprint and the evolving geography of AI demand. Without that, the "bond proxy" label is likely to persist.