Each morning you can read about yet another newly announced institutional and foreign investor diversifying its portfolio into data centers and digital infrastructure assets in the US and around the globe – and for good reason. Over the past few years, the sector has seen comprehensive growth. The quality and creditworthiness of the tenants and the stickiness of the physical plant to service the facilities have also added to the sector’s attractiveness. In turn, we are now seeing traditional multifamily, office, industrial and hospitality investors enter data center asset class by committing billions of dollars to acquire digital assets.
The industrial vertical is the top performing commercial real estate sector in the US, and includes warehouse, manufacturing, cold storage, telecom/data, flex, and R&D biotech. One of the major reasons for the industrial space’s growth over the past few years is the change in the way people shop. Online shopping has changed the demand from retail to industrial space for production and storage of goods, with 1.8 billion people shopping online in 2018. While e-commerce has impacted the retail sector negatively, it has propped up the industrial and the data center sectors positively.
Some of the large infrastructure funds like Brookfield Infrastructure Partners, Digital Bridge, Carter Validus, IPI and Macquarie have made major investments into the data center industry. There is as much capital inflow of smaller tranches from funds, family offices and foreign investment, all chasing the same assets. The amount of capital pursuing data centers versus the number of available data centers makes for great competition, compressing capitalization rates as well as due diligence timeframes, nonrefundable deposits and more, creating a sellers’ market. This scenario is coupled with a severe lack of experienced data center real estate professionals, who can educate and guide the smaller funds through the process of this unique asset class.
The process to purchase a multifamily asset is similar to a sale/leaseback data center, with the exception of the value at lease termination. The similarities end when evaluating the unique assets that make the data center attractive to the tenant, fiber, power, and the equipment left behind by the tenant. But is it valuable? If yes, what is its worth? You can compare an apartment that only needs a quick refresh of paint, carpet and update of appliances, to that of a data center which could need $5-7M per megawatt to lease up. The tendency for valuation at the end of the lease term is to put zero valuation on the equipment and little to no value on the infrastructure that makes the building a data center, and look to comps of flex/warehouse or even land basis depending upon the structure condition. Although this is a good “worst case scenario”, it does not provide a true view of the value, since there is value to the fiber and power. Data centers are not going away and according to many sources there will be a need for thousands of additional data centers over the next decade and power and connectivity can be the most difficult to acquire.