March  2010  VOL.3

Data Center Trends:
Sector energized by growing investment

It’s inconvenient, and sometimes embarrassing, when you go shopping or out to dinner, and your credit card is rejected. Most likely, it’s not your fault – you did pay your bill on time, right? Instead, a breakdown at a faraway and unseen data center is to blame. For you, a denied credit card is a mere nuisance, but for your credit card company, that same denial translates into the loss of millions of dollars per second and a furious customer base.

That’s why companies around the globe – in every industry and of every size – are investing in data centers, either by expanding into new buildings or upgrading their existing facilities and operations. In fact, data centers may well be the only sector in the commercial property world to have experienced growth over the past two years, and this niche sector continues to grow rapidly as demand surges and new investors enter the segment.

“Businesses from many industries, including commercial real estate, are rushing to get into the data-center industry due to the strength of this sector,” says Ab Atkins, senior vice president of KDC, a Dallas-based firm that recently formed an alliance with Digital Realty Trust Inc., a San Francisco-based REIT that owns and develops wholesale data centers. The alliance will handle build-to-suit enterprise data-center projects.

A recent survey of senior decision-makers at large corporations in North America found that 83 percent of respondents are planning data center expansion in the next 12 to 24 months, and 73 percent of respondents plan to add two or more facilities as part of their data-center expansion. Moreover, data-center and IT budgets are both projected to increase by 8 percent in 2010, up from 7 percent and 6 percent, respectively, last year.

The annual survey is conducted by research firm Campos Research & Analysis on behalf of Digital Realty Trust. “These survey findings point to strong demand for data-center space this year and next year as a large majority of enterprises expand their IT infrastructure,” says Chris Crosby, senior vice president of corporate development for the REIT.

Evolving technology

As technology evolves, the power and cooling needed to run these machines efficiently is driving growth within the sector, says Jim Kerrigan, leader of Grubb & Ellis Co.’s national data center practice. New, high-density, power-hungry data-center equipment warrants more advanced power and cooling capabilities, and most existing data centers are not able to handle these requirements.

Today’s data centers are vastly different than those built 10 years ago, primarily because of the increased densities of technology used within them. High-density technology applications such as blade servers require much more power and cooling than they did a decade ago, and these density trends are expected to continue well into the future.

“Ten years ago, most data centers were designed in an ad hoc fashion and the concept of outsourcing data-center needs was nascent,” notes Arjun Moorthy, vice president of infrastructure with SunGard Availability Services, which has 35 managed-services facilities with a combined total of more than 5 million square feet of data centers in North America and Europe.

As a result, most data centers grew in a way where design and maintenance were not consistent – leading to unpredictable reliability and uptime. Today, data centers are designed from the ground up with a singular or modular design and a long-term plan that is systematic and methodical, resulting in greater uptime and lower up-front and operating costs, Moorthy says.

Previously, most large “enterprise” companies chose to build and fund their own data centers rather than outsource. Although most companies would prefer to own their own data centers because of security and control reasons, the costs involved in data-center development and operations are usually prohibitive.

Most companies have decided to partner with “wholesale” data-center developers and owners, or co-locate their data-center needs with third-party providers for managed services. “Ideally, every company wants to own its own data center, but that’s not the best decision today given the credit crunch and the economy,” says John Patterson, a partner with Capstar Commercial Real Estate Services.

Dallas-based Capstar Commercial has partnered with The Cambay Group of Walnut Creek, Calif., to redevelop a manufacturing facility in Mesquite, Texas, into a state-of-the-art data center. Dubbed 3000 Skyline, the facility was formerly occupied by AT&T and Lucent Technologies.

The 90-acre site has its own power substation, along with dual electricity-transmission lines and fiber telecom. It accommodates all Tier III data-center design criteria as outlined by the Uptime Institute and is capable of meeting Tier IV design criteria.

When completed later this year, the property will have a power supply of 100 million watts – roughly five times the power usage capability of the new Cowboys Stadium. The facility will be delivered in shell form for tenants to build out.

Patterson says Capstar evaluated the site for nine months before deciding to acquire and redevelop it. The company, which has been involved in data-center redevelopment and leasing since the early 1990s, uses a 16-page feasibility checklist to determine whether properties can be transformed into data centers.

“The cost to build out a new data center is significant – it is one of the most expensive types of buildings to build,” Moorthy notes. “It takes considerable expertise to design, build, manage and maintain a data center. Companies need to have highly specialized skills to achieve high reliability and uptime for the equipment and network infrastructure, which is why many organizations turn to service providers.”
 

Digital Realty Trust’s survey found that eight out of 10 respondents with definite plans to expand in 2010 plan to do so with a partner that specializes in data-center design and construction or data-center leasing. More than half plan to do so by leasing from a wholesale data-center provider.

In the future, data centers will experience even more consolidation of servers and space, resulting in increasingly high-density systems with a lot more applications and equipment in a smaller space, according to David Atwood, general manager of Integrated Interiors at Work, a Boston-based company that provides preconstruction and design-build construction services for data-center environments. “It will be crucial to address power and cooling for the equipment accordingly.”
 

Power to the people

Today, the cost and availability of power is more important than the square feet leased or owned. In fact, the need for additional power is the top reason for data-center expansion, rising from fifth place to first place this year, according to Digital Realty Trust’s annual survey. For example, of those planning to expand, 70 percent are planning large projects of at least 15,000 square feet in size or 2 megawatts or greater of power.
 
“One of the most interesting pieces of data in this study is the lead role that power is now playing in these expansions,” Crosby notes, adding that the need for additional power has become the main driver for data-center expansion plans as companies look for facilities with adequate power and favorable utility rates to control operating costs.

According to research firm Gartner Inc., legacy data centers – those constructed during the last decade – are functionally obsolete, particularly when it comes to sustainability. The firm indicates that data-center managers run the risk of doubling their energy costs between 2005 and 2011 if they don’t do anything to mitigate the problem. Assuming that data-center energy costs continue to double every five years, they will have increased 1,600 per cent between 2005 and 2025.

As data-center usage continues to escalate and energy costs rise, energy efficiency has become a growing concern for data-center owners and operators. “The data-center sector is changing rapidly to adapt to the marketplace’s emphasis on energy conservation,” says R. Stephen Spinazzola, vice president and head of RTKL’s applied technology group. 

Spinazzola, who works on as many as 25 data-center projects annually, says the industry has recognized that it must focus on energy conservation because of the cost of doing business. Additionally, there are a number of efforts to create energy standards for the industry and growing pressure from federal agencies.

In February, for example, the U.S. Department of Energy and the Environmental Protection Agency announced an agreement on energy-efficiency measurements, metrics and reporting conventions for data-center facilities. Previously, there was no standard approach for such key questions as how to measure energy usage, where to take the measurements and how frequently to do the measuring. As a result, data-center operators had difficulty identifying energy-usage problems as well as potential solutions.

The new agreement provides guiding principles for data-center operators to gauge energy use and create opportunities for improved energy performance. By providing clear directions for data-center energy management, the groups participating in the agreement hope to spur data-center operators to improve their measurement practices, which will lead to higher efficiency and reduced energy consumption.

According to the DOE, power usage effectiveness (PUE) using source-energy consumption is the preferred energy-efficiency metric for data centers. PUE is a measurement of the total energy of the data center divided by the IT energy consumption.

“The current administration has a significant focus on energy and data centers (that?) are recognized as energy hogs,” points out Jerry Reich, a member of CBRE’s Project Management group and co-author of the firm’s white paper, Evaluating Your Critical Facilities. “This topic will become even more important as we address carbon tax law. It’s already a significant concern in the UK, where they will start that process in April.”

According to Reich’s white paper, increased focus and planning around design, construction and management of data centers is critical to corporate success, given the relentless demand for data storage, electronic communications and global economic connectivity.

Digital Realty Trust’s study found that 75 percent of companies are confident they can comply with future carbon-emissions-related and energy-related regulations. “There has been significant progress over the past two to three years in the area of data-center energy efficiency,” Crosby says. “Over that period, the industry has gone from power metering being the exception to power metering being utilized by more than three quarters of respondents.”

Moreover, Crosby notes that awareness of PUE is nearly universal now, with 96 percent of companies familiar with the emerging standard for measuring energy efficiency. “These are very positive signs that companies better understand their data centers’ energy use and be able to make informed decisions to reduce energy consumption,” he contends.

Today, the average reported PUE energy-efficiency rating for respondents’ data centers is 2.9; and one in six respondents report PUE ratings of less than 2.0 for their facilities.

Bringing economic growth

As the cost of data-center hardware and equipment continues to fall while energy costs continue to rise, decisions about where to locate a data center are being driven by energy rates nationwide.

For example, Apple is building a $1 billion data center campus in Maiden, N.C. The 500,000-square-foot facility will provide the company with a major East Coast infrastructure hub to support its iTunes music store and iPhone application store.

According to local reports, Apple’s data center will bring at least 50 high-paying jobs and another 250 support positions to Catawba County, where the unemployment rate is about 15 percent. Maiden has a population of about 4,000 people, while Catawba County houses roughly 157,000 residents.

“Rural areas have been attracting large Internet-based users due to the low cost of power and attractive tax incentives,” Atkins notes.

Many cities and states across the United States are rolling out the red carpet to data centers in the form of incentives. In the case of Apple, North Carolina reportedly offered the company an incentive package worth $46 million. Similarly, the City of Mesquite, Texas, offered Capstar Commercial incentives to transform 3000 Skyline into a data-center campus. Tenants at the project will also receive tax incentives, according to Tom Palmer, economic development manager for the city of Mesquite.

Although data centers usually are not labor-intensive facilities and don’t provide many jobs, the high cost of data centers and the constant investment in IT equipment can offer a tremendous injection into the local tax base, Palmer says.

“Data centers are very high-value assets, which means taxable revenue to the city,” Palmer points out. “And the jobs that are in data centers are high-wage jobs, and every city is interested in high wage earners. As far as I can tell, there are no negative impacts.”

Many experts contend that data centers have the ability to reinvigorate areas plagued by declining economies and populations. “When you look back into history, cities that found themselves at the confluence of a river developed as areas of commerce,” Palmer explains. “There was a geographical reason why some of these cities came to be. Data centers could recast the development and growth of future cities – it’s almost like discovering a river.”
 

Capital flows into data centers

With their focus on power and fiber connectivity, data centers are different from other types of commercial real estate “in just about every way you can think,” Atkins says.

Compared to other classes of real estate assets, data centers are depreciating assets and investors must underwrite them differently than other commercial properties. The leases usually include a service-level agreement and can involve quite a bit more than just the real estate, depending on the level of services the user requires.

Lease rates for data centers in shell form range from $35 to $65 per square foot, depending on location. Rates for turnkey space from wholesale providers are based on kilowatts and range from $150 per kW per month to $600 per kW per month.

Despite the opportunities within the data-center space, Atkins says it’s difficult to penetrate the sector quickly. “Barriers to entry are somewhat steep due to capital intensiveness and the complex technical skills required,” he says.

Nonetheless, the sector’s juicy returns – which can range from mid-teens to high 20s – are encouraging a lot of traditional commercial real estate investors to enter the data-center space. Institutional investors and private equity firms also are active in the sector, Kerrigan notes.

Earlier this year, for example, National Real Estate Advisors (NREA) partnered with Seattle-based data-center developer Sabey Corp. NREA, the real estate management firm that advises the National Electrical Benefit Fund, a multi-billion-dollar pension fund for electrical industry employees, plans to invest $100 million so Sabey can grow its business outside its home state.

“Capital is chasing existing developers who have done well in the space,” Kerrigan says, adding that private equity players are more active in the data-center sector than anyone else. For example, General Atlanta LLC, a Greenwich, Conn.-based private equity firm with $14 billion under management, recently invested $150 million with Quality Technology Services, a Suwanee, Ga.-based data-center developer and owner.

“If I had the money, I would look at this sector very closely,” says CBRE’s Reich. “The demand is there and the return is there. If I were going to put money in real estate, I’d put it in data centers because at the end of the day, a data center is the lifeblood of corporate America. If a data center goes down, a company is dead in the water.”