Technology is evolving exponentially. On all fronts—business, consumer, user—the Internet has become a necessity. Whether saving company files to the cloud, shopping on Amazon or streaming Netflix, all this data flows through one commercial real estate property type: data centers.
This greater demand for data presents a significant opportunity for investors in data center properties.
“Corporate clients in the past five years have migrated quickly from owning data center properties to sale/leaseback, colocation, managed services. They are more focused on third-party solutions (colocation, cloud, managed services), as well as flexibility for these services,” says Patrick Lynch, managing director for data center solutions at real estate services firm CBRE.
In stepped the REITs, which have largely taken over operation of these facilities. The data center sector alone makes up 5 percent of the overall value of all REITs, according to Lynch.
“Specialty REITs (primarily cell towers and data centers) have dominated capital issuance in all forms over the last several quarters and have outpaced the rest of the sector combined year-to-date,” according to Fitch Ratings’ U.S. Equity REIT Outlook.
The data center REITs have experienced accelerated growth this year as a result of rising demand, says Steven Marks, managing director with Fitch. He expects the trend to continue. “Data needs to flow through somewhere,” he notes.
According to research firm the CoStar Group, in the first two quarters of 2016, investment in data center properties totaled approximately $634.6 million and encompassed 4.4 million sq. ft. of space, compared to $494.6 million in investments sales closed in the first two quarters of 2015 encompassing 5.7 million sq. ft. of space. It appears data center property prices have gone up.
For the whole of 2015, the total volume of data center sales nationally was approximately $1.11 billion, and included 10.89 million sq. ft. of space.
Not your average buildings
These specialized properties (consider that a typical facility has a 24 ft. ceiling height, with a 46-in. raised floor to store cooling and electrical wiring) need juice. Electricity consumption measured in megawatts is the metric that primarily defines fundamentals and deal structures in the sector, as opposed to the square footage metric used by the rest of the commercial property types.
“In this sector, you can run out of power before you run out of space. Valuations are based on power. Deal is typically structured at kilowatt per month plus utilities,” Lynch says.
Data centers can be split into two sub-types: wholesale data centers and carrier hotels.
The wholesale data centers are akin to “Costcos of data centers,” and produce between 100 and 200 watts per sq. ft., according to Lynch. Their total power usage can exceed 100 megawatts and they can be as large as a million square feet in size.
Meanwhile, carrier hotels are “small locations for interconnectivity and data hand-offs, primarily in CBD areas.” These properties span from 100,000 to 200,000 sq. ft, with the maximum size producing 75 watts per sq. ft.
CBRE’s outlook for the sector is wholly positive this year, as developers increase construction to answer the unending demand for supply.
“Fortune 1000 Enterprise clients continue to expand their IT infrastructure,” Lynch says.
Investment dollars are mostly going into core data center markets: Northern Virginia (with 4.9 percent vacancy), Silicon Valley (with 7.3 percent vacancy) and Chicago (with 4.3 percent vacancy).
“Northern Virginia is competitively priced, has close proximity to undersea cables, low latency connection to Europe, robust connectivity ecosystem and significant regional and global demand,” Lynch says. These are key qualities in site selection for this asset class.
They are also the qualities that can lead to oversupply in select markets.
According to Marks, Northern Virginia and Northern New Jersey are two areas where investors are “most concerned about supply/demand fundamentals, as these markets are prone to overbuilding.”
First-generation data centers built in the 1990s might require additional redevelopment dollars after they are purchased. Many of these properties are under-powered or inefficient and need to be brought up to speed. In some cases, the buyers may look to expand modularly based on demand if space becomes an issue.
Usually, new owners/operators choose to replace equipment, funding the investment from their recurring cash flows, Marks says. Knocking down a data center to build from scratch is “cost-prohibitive,” he adds.