Cloudy with a Chance of Windfall: Major cloud providers anticipate tripling their infrastructure by 2020, which is good news for the data center real estate sector
- November 1, 2017: Vol. 4, Number 11

Cloudy with a Chance of Windfall: Major cloud providers anticipate tripling their infrastructure by 2020, which is good news for the data center real estate sector

by Michael Lester

Data needs a home. It can live in a small back room of a big office; it can live in servers stacked in cabinets arranged in hundreds of rows in huge warehouses. A data center is a hardware store full of servers, storage devices and network connections.

“On a non-weighted percentage, the overwhelming majority of data centers are tiny closets and rooms with a handful of devices,” says Todd Smith, chief technology officer at Transwestern Data Center Solutions. “But on a weighted basis, IT infrastructure has been moving at an accelerated pace to large, third party–managed facilities.”

And right now, publicly traded REITs are becoming dominant as the third-party owners of data centers. “The U.S. REITs — and one in Europe — make up about 25 percent of the global market of third-party data center owners and operators,” says Smith.

“It’s very difficult to be a one-off developer,” says Jeff Kanne, president and CEO of National Real Estate Advisors. “As an operator, you have to have a stellar reputation, making sure your data centers are up and running 99.999 percent of the time. That’s an industry standard used to determine if you’re a good operator or not. As opposed to a net-leased Walgreen’s building or an office, the people buying your building and services are not likely to take a risk on a newbie in the market.”

Although it is still a fragmented market, REITs have been on a merging and buying spree. They can provide two things data centers need — a global footprint and access to capital. “The REITs have tenants who may need deployment in Singapore, in Amsterdam and in various spots in the U.S.,” says Jeff West, director of data center research at CBRE. “They stitch together centers into a network. All the REITs have built their own facilities but, in some cases, they also have been acquiring facilities.”


Data center development requires capital. Centers are not only land, bricks and mortar. To keep computers humming, centers typically have a redundancy of switching gears; handlers; and mechanical, cooling and power systems, including emergency backup power generators. “In traditional real estate, investors measure returns based on square footage; in data centers, those metrics are often measured around wattage,” explains West. “Rents are typically not based on square feet but on the power capacity being used.”

We are talking mega megawatts. Even though JLL in its Data Center Outlook for 2017 predicts, “U.S. energy costs and regulations for the industry are expected to be reduced across the board,” large data centers use as much electricity as a small town — 40 to 80 times the energy of traditional office space. Although energy costs may decrease in the short term, energy use over the past five years has doubled. According to the high-tech research firm IDC, data center customers have increased their server capacity by six times over the past 10 years and their storage capacity by 69 times.

“Data centers have become a core property,” says Kanne. “The computing tasks are taking place in the data center, not in your phone or laptop or private server room. Twenty years ago, data centers were a nice convenience, but your business could live without them. Today, the existence of your company depends on data centers.”

Frank Garcia, portfolio manager for PGIM Real Estate’s flagship U.S. core equity real estate fund, uses the word “robust” to describe the marketplace. “Data center demand-growth prospects are favorable, and fundamentals should remain healthy in the near term. Technologies such as mobile Internet, machine learning, the Internet of things, and the like are becoming increasingly important in everyday life. The data storage and computing capacity required by these technologies have been growing exponentially and will continue to do so for the foreseeable future.”


All this talk of servers and computing and megawatts can send us into the clouds. With more data being created and accessed by more companies more often, the cloud offers a silver lining. Businesses are handing over some or all of their technology infrastructure to third-party providers. According to a 2017 report by CBRE, the marketplace is thriving, in part, because of “multi-megawatt leasing by hyperscale cloud service providers.”

The biggest cloud providers are Amazon Web Services, Azure (Microsoft Corp.), Google Cloud (Alphabet Inc.), IBM Cloud (IBM Corp.) and Oracle Cloud (Oracle Corp.). They are investing billions of dollars every year into cloud research and development. According to The Wall Street Journal, the top three — Amazon, Microsoft and Google — spent $31 billion in 2016 to expand and extend their data centers around the world.

The digital cloud is just as tangible as a cloud in the sky. Remember: Data needs a home. According to JLL’s Data Center Outlook report, major cloud providers are anticipating they will triple their infrastructure by 2020. That is nothing but good news for the data center real estate sector.

The major hubs for data centers in the United States usually are ranked in this order: North Virginia, Houston, Dallas, Northern California’s Silicon Valley, New York/New Jersey, Chicago, Boston, Atlanta, Phoenix and Southern California. Market conditions in all the major markets, according to the JLL report, are landlord-favorable, and “hub market activity remains sky high.”

Average rental rates for a Tier III colocation (used by more than one business) center have stayed rather consistent over the past couple of years at $125 to $145 per kilowatt per month. But rental income can be derived from more than electrical power or floor space. “Some operators focus on interconnection and access to cloud platforms,” says West. “Others are more wholesale-oriented; they may have a robust facility, but tenants install their own equipment, and the rental arrangements can be more akin to triple-net leasing.” He conjures up a Russian nesting-doll model: “Centers can be leased to a cloud provider, or to a nontechnology enterprise, or a colocation provider, or all of them. It can get a little convoluted.”


Here is a scary vision: The “lights-out” data center, also known as a “darkened” or “dark” data center. Everything, ideally, is working, but nobody is home. Because of the lack of need for personnel to enter the building, it can be operated without lighting. According to Designing a Total Data Solution, edited by Roxanne Burkey and Charles Breakfield, “all of the devices are accessed and managed by remote systems, with automation programs used to perform unattended operations,” resulting in “energy savings, reduction in staffing costs and the ability to locate the site further from population centers.”

“You may have a hundred different companies using one lights-out facility because they don’t need to have their IT people sitting at the facility,” says Smith. “Lights-out facilities still need people, but not a lot of people. Most of the hardware can be managed from your home or office.”

On the other hand, saving energy and lowering costs are possible without the creepy vision of a landscape dotted with lights-out centers. There is a trend among data center developers and owners to build and operate green buildings and to use renewable, alternative energy. Following customer demand, Equinix, which operates more than 175 data centers around the world for clients including Google, Adobe Systems and Microsoft, recently agreed to buy solar energy for its California facilities. The REIT intends to eventually power all of its data centers with clean energy.

With 60 percent of the operating costs of data centers being electrical and mechanical, alternative energies such as solar and wind power are increasingly popular in the United States.

“Our strategy is to employ as much low-cost renewable power as possible, so about 80 percent of our energy is hydroelectric power,” boasts Kanne of National Real Estate Advisors. “There will not be more hydropower in the United States because it is virtually impossible to build new dams. There is a lot of hydropower in Canada and Scandinavia, but there are legal impediments to storing data in a different country, as well as connectivity issues. And many U.S.-based businesses do not feel secure having their data or cloud services in a foreign country.”

Investing in real estate hitched to new technology has a surreal component: The IT landscape changes faster than a teenager’s photos on Snapchat. In 2007, the first iPhone appeared. A lot can happen in 10 years.

Kanne has heard it all before. “Some people think, ‘It used to be that computers and cell phones were the size of a desk. Now look: They’re so small you can barely hang onto them. Doesn’t that mean that the stuff inside a data center will be getting smaller, too? And we’ll need less data center space.’ No, it doesn’t. That way of thinking leaves out the critical ingredients of electricity and connectivity. No one has conceived of a way to do digital computations without electricity. And you need hardware to make digital computations. The number of compute cycles has gone through the roof and is growing exponentially. The more compute cycles, the more demand there is for data centers.

“Ford Motor Co. now calls itself a technology company,” continues Kanne. “They know that driverless cars are right around the corner, and the computing power needed in a single driverless car will produce as much data in one hour as the current usage of a smart phone would produce in decades. Think about that: When we have 50 million driverless cars on the road, what will be the demand on data storage and computing? Historically, the long-term limits on demand don’t exist, and I don’t see that changing in the foreseeable future.”

As Smith points out, “It’s a secular change, a change in our culture.”

A lot can happen in 10 years. But our addiction to electronic data — games, emails, tweets, photos, you name it — will not disappear. Real estate is merely responding to this pervasive and insatiable thirst for data.


Michael Lester is a freelance writer based in Northern California.

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