'They're Patting Every Pocket': Data Center Developers Struggle To Finance Projects Despite AI Boom

The ballooning volume of capital required at the beginning stages of the data center building process is forcing developers and investors to find new ways to raise the money needed to buy land and secure power. 

From a financing perspective, the start of a data center project presents something of a Catch-22 for developers. They need more upfront cash than ever before to purchase land and secure power for those sites, yet lenders and equity investors have largely been unwilling to provide the predevelopment capital required to navigate these early stages.

New solutions are emerging to address this problem.

Data center firms are finding novel ways to convert existing data centers into cash on their balance sheets, giving them the liquidity needed to move forward with land and power deals prior to project-specific financing. Additionally, a new crop of investors are introducing innovative deal structures and strategies that are helping developers bridge this critical financing gap, injecting cash at a time developers need it most.

“They have to pull from every resource,” said Jeffrey Stern, a partner in the structured finance practice at Reed Smith who is active in data center deals. “They’re patting every pocket on their vests to see where there's some change left.”

Despite artificial intelligence driving an unprecedented wave of data center construction, traditional capital sources are still wary of providing early-stage financing before an end user is secured. And the upfront capital requirements for developers are only getting bigger. 

The cost of developable data center sites has shot up, with prices for U.S. data center land parcels of at least 50 acres jumping by more than 23% last year, according to Cushman & Wakefield. 

The skyrocketing costs of bringing power to a data center site have been an even bigger factor in the increased capital needs. 

Utilities and grid operators have become concerned they are spending billions on infrastructure improvements to serve data center projects that may never materialize. To mitigate this risk, utilities and state governments are enacting measures requiring data centers to make upfront capital commitments to receive — or in some cases, just apply for — power.

The required payments for major data center projects in some cases have been north of $400M.

Some developers are pursuing alternative methods to get power to potential data center sites, often through natural gas generation or other forms of on-site power. These solutions also come with huge predevelopment infrastructure costs. 

The result of these rising costs is something of a chicken-and-egg financing scenario facing data center providers: Without a tenant already in place, it is nearly impossible for data center developers to find financing. But securing a tenant requires hundreds of millions of predevelopment dollars for land and power — liquidity that many capital sources are unwilling to provide. 

With speculative financing rarely an option, developers’ ability to navigate the predevelopment phase often requires them to have liquidity already on their balance sheet to fund land and power acquisition, rather than looking for financing on a project-by-project basis. This is easier said than done, but developers, lenders and equity investors are getting creative and forming new tools to help data center firms build pools of development capital. 

Cash-strapped developers are increasingly turning to capital recycling: selling stabilized assets and using the proceeds to fund new projects. The growing need for capital recycling has spawned firms specializing in data center deals for exactly this purpose. An increase in the number of stabilized data center sales is expected in the coming months, according to JLL. 

Still, there are few potential buyers of stabilized data centers relative to the number of companies looking to recapitalize these facilities. As a result, the need for capital recycling for land and power acquisition has been one of the forces driving the growth of securitized debt backed by data centers. 

Data center asset-backed securities and commercial mortgage backed securities — almost unheard of as recently as 2021 — have quickly become a major force in global debt markets. Just five years after the first single-asset, single-borrower CMBS deal for the sector, data centers last year accounted for 13% of such transactions, according to Goldman Sachs. Roughly a quarter of the value of these securitized loans is typically recycled into funding new development. 

While Stern said capital raised through data center ABS and CMBS isn't being used exclusively to fund predevelopment, it represents a meaningful slice of that pie. 

“Some of them may indeed have a chunk of capital that they pull out and reuse,  there may be others that are buying land and then are … building some of the infrastructure and then monetizing it over time — there’s a spectrum of variations to that,” Stern said. “But in all of these cases, these are important tools to provide liquidity.”

Other firms are finding new ways to tap private debt markets for the same purpose. 

Data center REIT Digital Realty launched a $3.5B development fund for institutional investors, a fund that owns a portfolio of its stabilized data centers. This represents a novel approach to capital recycling: Investors get a steady stream of income from the fully leased data centers, while Digital Realty uses the invested capital to cover predevelopment and development costs without raising project-specific debt. 

Digital Realty told investors earlier this month that the fund is part of a $15B liquidity pool from private capital it calls “dry powder” to bank land and power ahead of demand to be able to deliver capacity on short timelines when Big Tech tenants need it.

“Most of all the other private capital folks are waiting for that lease to get signed, because that lease secures the financing and the lion's share of the dollars for their project,” CEO Andrew Power said on the company’s fourth-quarter earnings call. “That has accrued to our benefit because customers have come and said, ‘I need this desperately, can you help me?’ And we're able to deliver that.”

Although this kind of private debt strategy or the issuance of bonds are viable paths to liquidity for the industry’s largest and most well-established developers, they aren't options for the many smaller or newer firms.

As a result, new approaches to bridging the early-stage capital gap are beginning to emerge across the data center development and financing ecosystem. 

One of these new entrants is Accelerate, a real estate investor that aims to partner with developers to acquire the land on which a data center campus will be built and lease it back to that developer. This effectively provides a cash infusion that is paid back gradually in the form of rent. 

Accelerate Chief Revenue Officer Graeme Kavanagh said this strategy can reduce the capital developers need to deploy in predevelopment, allowing their available liquidity to be steered toward power acquisition or other parts of the development process, driving faster speed to revenue. 

“Their money is sunk in the dirt. It's a sunk cost to the development. We can free and recycle that capital for them by buying that property and leasing it back in just a straight sale-leaseback structure,” Kavanagh said. “Are you better off taking $60M and putting it in the dirt or keeping that $60M in the project?”

Another nascent subsector of data center investors is taking a “venture capital” approach to the acquisition of land — willing to take significant risk on multiple projects at the pre-powered land stage but seeking significant returns.

Jeffrey Moerdler, chair of the data center and digital infrastructure practice at law firm Haynes Boone, highlighted one such client with capital spread across 14 separate speculative powered land deals. The monetization of just one of those projects means the investor would see a return of 10 times their invested capital.

This is a niche that Moerdler and others say needs to grow to help bridge the predevelopment data center financing gap. 

“There's also a big need for very early-stage, very non-risk-adverse capital,” Moerdler said in December at Bisnow’s DICE: West event. “That's a huge untapped market. We need people who are willing to take those risks.”