Despite AI Boom, Future Of California's Data Center Market Remains 'An Open Question'

California is losing its status as a data center hotbed.

But developers are still finding opportunity in the state, while local governments are getting creative to help data center firms overcome California’s high costs, resource shortages and famously high regulatory hurdles. 

California’s position as the epicenter of the tech universe is stronger than ever as Silicon Valley drives the artificial intelligence gold rush. But even as California-based firms such as Google, OpenAI and Meta fuel a digital infrastructure building boom that could see more than $3T in construction spending by the end of the decade, the share of that development capital staying in the state is getting smaller. 

After years as the second-largest data center market behind Northern Virginia, Northern California is now ranked ninth among U.S. data center markets by total capacity, according to JLL. Southern California is ranked No. 12. 

Driving this decline, industry leaders said at Bisnow’s DICE: West event last month at the San Jose Marriott, are long wait times for power and an unfriendly business environment. They said California has high regulatory hurdles and costs compared to other markets, and, given the choice, data center developers are looking elsewhere.

Despite the difficulty of building, Big Tech's presence has bolstered data center demand in California, and tenants will jump at the opportunity to snatch up any capacity that can be delivered. 

In San Jose, city officials and utility PG&E have forged a novel partnership to help developers navigate these economic and bureaucratic barriers, an effort they hope will make the city the next data center boomtown and create a template that could change the trajectory of the state’s fortunes.

“We're the home of the tech industry — we power the world's tech, and why wouldn't we continue to do that?” PG&E CEO Patti Poppe said. “If we're not careful, we lose the chance, and I think that's an open question for California right now.”

The problem in California isn’t that tenants don’t want to be there, industry leaders say, it’s that California has become a uniquely challenging place to build data centers. 

Developers speaking at DICE: West described a burdensome regulatory environment in the state that makes it nearly impossible to get data centers to market quickly. In an industry where speed to market is critical, California’s complicated state-level permitting and entitlement processes make development timelines longer and less predictable than in other markets.

California’s regulatory landscape is also exacerbating power constraints by slowing down the build-out of new energy infrastructure, panelists said. While wait times for grid connections have stymied development in data center markets across the U.S., the problem has been particularly severe in California. In 2023, developers looking to build in Silicon Valley were informed by utilities that they would need to wait a decade for power connections.

The state’s data center expansion has also been hindered by the high costs associated with both construction and operation. The most significant operational expense for data centers — electricity rates — are twice as high in Silicon Valley and other major California hubs compared to the industry's leading growth markets, panelists said. At the same time, construction costs have risen sharply in the state, in part due to costs related to navigating permitting processes.  

The challenges of building in California have led hyperscale development to shift to states such as Arizona, Oregon, Nevada, Utah and Texas. 

“I spent 10 years and $10M trying to get a project going in California and decided to go to Texas,” Calvano Development President Mark Calvano said at the event. “My first deal [in Texas] was in Wichita Falls, where the planning director said we’d have to do a zoning change on our 220 acres and it would take six weeks and $320. In five weeks, it was done.”

Still, other panelists cautioned that it would be a mistake for developers to write off California entirely. While California presents challenges for building new data centers, tenant demand in the state remains as strong as ever. Markets like the Bay Area have the highest rents in the country, with vacancy rates approaching zero, according to JLL. 

California is expected to see almost none of the multigigawatt campuses making headlines elsewhere. But the state is expected to experience a steady stream  of what Global Compute Infrastructure CEO Scott Peterson calls “boutique, niche, infill development.”

He said this will mean smaller data centers of less than 100 megawatts, leased to tenants willing to pay top dollar to be close to tech hubs and populations centers such as the Bay Area and Los Angeles. 

The region's high concentration of tech talent and AI companies ensures strong demand for low-latency, easily accessible computing resources needed for AI development. Poppe said this is reflected in PG&E's interconnection queue, where nearly all of the 10 GW of data center power requests are for small projects, less than 100 MW, spread across its service area.

Those may seem like small data centers relative to the megacampuses being built elsewhere, but Primary Digital Infrastructure Managing Director John Sheputis urged others at DICE: West to keep this scale in perspective, as these projects represent significant capital deployments with capacities equivalent to the entire Silicon Valley market just a decade ago.

“A hundred megawatts — that's a billion and a half dollars,” Sheputis said. “California still has 40 million residents and serves up network to half the country. So just like the people who live in California are the people who can afford it, the applications are going to be here that need to be here.”

As far as building those data centers, efforts are emerging between local governments and utilities in California to alleviate regulatory roadblocks.

In July, PG&E and San Jose announced a partnership to streamline the permitting and power acquisition processes for data center developers and deliver 2 GW of new power capacity for data centers by 2028. Beyond just making more power available, the partnership aims to create a single-service delivery team between the city and utility to simplify the regulatory and permitting processes facing developers and ensure predictable delivery timelines.

The intent is to guide data center builders through the power acquisition and entitlement processes to bring new data centers to market as fast as possible, said Erica Garaffo, large load energy customer development lead for the city of San Jose.

“We're obviously not Texas, and we understand that California has its own regulatory hurdles. That being said, we would like to move as fast as we can,” Garaffo said.

“We’re trying to make sure that we are looking around corners to make sure that we are advising developers on the steps that they need to take — you can choose this path and it will be done in a day or two, or you could choose that path and it will be eight months later. We can use our guidance to accelerate and improve the process for developers.”

These efforts are already bearing fruit. Last week, Equinix energized the first project to receive power through this partnership, doubling the capacity of its San Jose data center to 40 MW. The city also reached an agreement with Prologis, which would build up to four data centers on a 159-acre site, with PG&E providing at least 250 MW of power. 

The partnership is the first of its kind in California, but officials from San Jose and PG&E say it should be a model for other municipalities looking to attract data center developers that might otherwise be scared off by the state’s regulatory risk. 

“I would encourage other municipalities to follow suit, with the two sides of the regulatory chapter working together,” Garaffo said. “San Jose is a regulator, PG&E is a utility. We’re sharing information, working closely with developers to make sure that we are aligned on the power side and on the land use side, all working in concert.”