More Power to the Data Center Market

Imagine where data center development would be without supply chain disruptions and a lack of available power and land in some major markets.

Pat Lynch, executive managing director, global head of advisory & transaction Services, data center solutions, CBRE, said in prepared remarks that those factors could delay new construction deliveries over the balance of the year and beyond.

Nonetheless, according to CBRE’s latest North American Data Center Trends Report, the percent of new megawatts that went online in the seven primary data center markets was up, year over year, by 20 percent.

Meanwhile, data center vacancy decreased to an average of 3.8 percent across the seven primary markets in H1 2022—down from 10.3 percent in H1 2021—as large cloud users raced to secure space to accommodate anticipated future growth.

Significant preleasing of space under construction in prior years contributed to the large drop in vacancy, according to the report.

Lynch added, “As a result, we expect continued rising rents nationally, and more occupiers turning to secondary and tertiary markets to meet their needs. These smaller markets will also continue to benefit from an increase in edge data center deployments, driven by broader adoption of AI, 5G and blockchain technologies.”

Powerful Numbers

According to the report, “For the first time since 2017, tight market conditions caused average asking rents to increase in both primary markets (5.9 percent to $127.50 per kW) and secondary markets (2.3 percent to $133.00 per kW).

“Primary-market vacancy will remain tight for the foreseeable future, as 73 percent (1,170 MW) of the 1,601.5 MW of the under-construction supply was preleased as of the end of H1 2022.

CBRE said Northern Virginia remained the most active data center market with net absorption of 269.3 MW—a 281 percent increase from H1 2021—and more than quadruple that of Silicon Valley, the next highest market.

Capacity ‘Incredibly Tight’

Andy Cvengros, JLL Managing Director, tells GlobeSt.com, “Current capacity is becoming incredibly tight, especially with large blocks of space, across all major markets. Highly desired submarkets could become nearly sold out in 2023.

“While there is substantial capacity coming on-line in 2024 as we catch up with supply chain delays, many campuses that are under development are entertaining multiple offers or are fully pre-leased,” Cvengros said.

“The demand we are seeing from hyper-scalers is unprecedented. Most markets saw a 200% to 300% increase in absorption. This is driving land banking, assemblage, and bullish buying by developers.”

Data Centers: Let the Good Times Roll

Green Street senior analyst David Guarino tells GlobeSt.com that the data center sector “is experiencing unprecedented global demand, creating a favorable operating environment for landlords.”

From Guarino’s “Let the Good Times Roll” report on data centers from Aug. 15, he shared that leasable space has become scarce; vacancy is near all-time lows.

“Too much growth too fast has created bottlenecks for new projects,” he said. “And development pipelines are largely pre-leased with wait times pushing into 2023.

“Existing data center landlords to benefit from low inventory; rents are rising. M-RevPAF estimates are increased; low-single digit growth ahead.”

He said the debt markets have cooled and cap rates are higher by 25-50 bps from start of 2022. There’s a $10 billion Global Switch portfolio for sale and bidders are likely circling.

Data Center Inventory in Just Seven Markets

Doug Ressler, business manager, Yardi Matrix, tells GlobeSt.com that the growing interest in data centers continues to be heightened by the demand for e-commerce, which has only increased throughout the COVID-19 pandemic.

According to CommercialEdge, the second quarter of the year saw $222.5 billion in e-commerce sales, an overall 3.3 percent increase from Q1 2021.

Data center inventory is primarily located in just seven markets, which includes Washington, D.C.; Dallas–Fort Worth; Chicago; the San Francisco Bay Area; New Jersey; Phoenix; and Atlanta.

“However, the data center segment could continue to grow should with the with the Infrastructure Investment and Jobs Act becoming law,” Ressler said.

“The law has a massive impact on data center demand because it allocates $65 billion to increase the number of broadband users nationwide. Primarily, the law would eventually connect the 23 percent of Americans who do not have access to broadband, potentially opening new markets for data centers.

“One of the reasons is because of the tremendous amount of information that’s growing exponentially. It must be handled and maintained, not only from a cybersecurity standpoint but from a volume standpoint. We see that all industries are contributing to that. From a cost standpoint, many times it’s a cost benefit to be able to outsource to the data centers…we see that as a lucrative type of business right now.

Ressler pointed to huge caveats. First, data centers do not have that many employees. Data center facilities often don’t pay their way in regional revenues because they don’t typically generate sales tax – only property tax – “and then they don’t necessarily contribute greatly to local spending because of the limited number of employees,” he said.

Second, “Despite best efforts to thoroughly vet a location for seismic activity, vulnerability to natural disasters, talent availability and abundance of bandwidth, unforeseen circumstances can still derail a project,” he said.

“For example, the sheer complexity of data center construction is a risk. The project typically involves multiple vendors, subcontractors and as many as 50 different disciplines in areas like structural, electrical, HVAC, plumbing, fuel pumps, networking, and security.”

Construction Equipment Limited

Thomas Galli, partner at Duane Morris, tells GlobeSt.com that many factors are affecting the delta between supply and demand for data centers across markets and in specific markets, including the supply of equipment required to construct and operate data centers.

“As demand for data centers has substantially increased over the last few years, and is anticipated to further increase, the time to fill orders for equipment has increased as manufacturing capacity has reached limits and been affected by disruptions to supply chains for necessary components,” Galli said.

“Larger owners and developers of data centers (e.g. data center REITs) got in front of this factor long ago by leveraging the volume of equipment they order to obtain preferred status for the supply of that equipment. This is a competitive advantage they use to market their data centers to hyper-scalers for faster and more certainly of delivery of data centers to their customers across the globe.”

Galli said the availability and price of land affects the delta between supply and demand market-by-market.

“While land is generally available to construct new data centers in markets, prices have increased meaningfully in the largest of markets in the US and those price increases has been easily absorbed to date,” he said.

“Those increases in the price of land have also caused data centers to go vertical with multiple stories – generally limited to two or three stories. As land prices further increase in the largest of data center markets, expect data centers in those markets to get taller as additional construction costs for more stories is cost justified. Subject to local zoning laws, there is no reason data center buildings can’t get much taller.”

As demand for data centers continues to substantially increase, we should expect more competition in the largest markets with supply of power and increasing scarcity of land unable to keep pace with demand.