'We're Pretty Much Sold Out': Development Woes Drive Down Data Center Leasing
Data center leasing numbers are down this year after several record quarters, but experts say that is the result of mounting development challenges rather than slipping demand.
Net occupancy gains in the North American data center market during the first three months of this year were the smallest since the third quarter of 2021, a precipitous decline after almost two years of record growth, according to a new report from industry analyst group Data Center Hawk.
But while there are indicators that the pace of demand for new data center space has tempered slightly in certain segments of the industry, experts say lower absorption numbers primarily reflect a shortage of new inventory coming to the market.
With vacancy rates south of 3%, hyperscalers and enterprise tenants are still snapping up data center capacity as fast as it can be produced. Yet growing challenges ranging from power constraints to supply chain delays and labor shortages are lengthening development timelines and making it increasingly difficult for data center providers to deliver the kind of campus-scale projects that drove record leasing.
“It's completely about supply, in my opinion,” said Wes Swenson, CEO of Novva Data Centers. “We're pretty much sold out. The bulk of my inventory is not coming online until early ‘25. I think that’s true nationwide. If somebody needs 10 to 20 megawatts within 12 months, I don't know where they would ever find it.”
The top 18 U.S. and Canadian data center markets recorded a total of 436 MW of net absorption during the first quarter, according to the Data Center Hawk report. Although this is the sixth-highest quarterly total on record, the five best quarters all came in the 15 months before it. And the Q1 total represented a sharp drop from more than 700 MW of absorption at the end of 2022 and around 900 MW in Q1 last year.
Absorption is often viewed as a key indicator of demand, and the numbers come amid signs that the record demand growth the industry experienced since the start of the pandemic has begun to moderate. Major cloud providers like Amazon Web Services, Google and Microsoft were largely responsible for driving record leasing numbers, but as the cloud industry’s revenue growth has tempered in recent months, so has its infrastructure spending.
While these tech giants are expected to drive a surge in new data center demand in the coming years to support their rapid expansion in the artificial intelligence space, this demand hasn't yet materialized in leasing markets.
At the same time, Data Center Hawk’s analysis points to what it calls a “pause” in enterprise spending on data centers as companies make more conservative IT spending decisions and delay new leases due to volatile macroeconomic conditions. It is a trend Equinix CEO Charles Meyers acknowledged on the REIT's earnings call last month.
“Customers are feeling tighter budgets and looking to stretch their dollars,” Meyers told analysts. “Clearly, you're feeling a little bit of caution in the macro market.”
Headwinds may be slowing demand, but industry insiders told Bisnow the drop in absorption since the start of the year is all about a lack of supply. Simply put, there just isn't as much new data center space to lease.
Experts said the pace of new data center development has slowed, and the industry’s 2.88% vacancy rate is a reflection of a data center leasing environment where supply is trailing well behind demand. It is also one where tenants have to snap up capacity months or years before it is built to avoid being shut out of the market entirely.
“You're talking about somebody signing up for a building where construction might not even commence on it until 24 months from now and where the delivery of that building is four years from now,” said Ali Greenwood, executive director in Cushman & Wakefield's data center group. “That’s not necessarily something that sounds crazy in New York or Chicago or LA’s office market, having a build-to-suit project that won’t be delivered for years, but that is crazy in the data center world.”
With so much hunger for new data center capacity, why isn’t more being built?
Experts pointed to a pair of connected trends that has slowed the delivery of new inventory even as a flood of new investors looks for opportunities to deploy development capital in the data center sector. Cloud providers and other major tenants are looking to lease on a larger scale than ever before, and at the same time an array of factors has made developing the massive facilities and campuses needed to meet that demand more difficult than ever before.
As recently as three years ago, the largest leases rarely exceeded 12 MW. Now, that kind of lease would be on the small side. Hyperscalers are looking for dozens of megawatts at a time, often leasing whole facilities or entire campuses that can be scaled up to 100 MW or more to meet the needs of pandemic-accelerated digital transformation. It was largely these massive leases that drove record leasing numbers over the past six quarters, Greenwood said.
“The hyperscale activity that was growing and consuming so much of the absorption since 2021, those were 44 MW on the small end to 100 MW commitments — very, very large transactions,” Greenwood said. “It takes only a couple of those to set record-breaking absorption in the market.”
But sites where data center development at that scale is viable — and particularly where a facility can be built quickly — are increasingly rare. While factors like fiber connectivity and proximity to major economic hubs are always a big part of data center site considerations, experts said that today, more often than not, the limiting factor is access to power. It has become far and away the largest consideration when it comes to where data centers are built.
“Where is power, how much power is available and what is the cost of power? That’s one, two and three in terms of priorities for data center development,” said Gordon Dolven, director of data center research at CBRE.
Developing digital infrastructure at this scale doesn’t just require a local utility producing enough power for a 100 MW data center at a rate that will be acceptable to tenants. The site needs to have access to the high-voltage transmission lines that deliver the power, along with a substation and other infrastructure.
But this low-hanging fruit, the sites where immediate access to power already exists, has effectively disappeared in major data center markets, snapped up by developers as the data centers sector’s growth has strained local power infrastructure in places like Northern Virginia and Silicon Valley. Even newer high-growth markets like Phoenix see looming power constraints that could limit development.
In most major markets, building a large data center or campus now often means either building out power infrastructure like transmission lines and substations or waiting for a utility to do it for you. And this has dramatically slowed the pace at which new facilities can be built. Prolonged supply chain constraints mean it can take years just to acquire equipment like transformers, and that is in addition to the significant permitting and regulatory challenges associated with building out power infrastructure.
“A substation transformer for us is a two-year lead time. … Between the pandemic and demand, [the supply chain] really has not caught up,” Novva’s Swenson said. “With the increased demand that we're seeing for compute, I think it's going to be this way for quite some time. Four to five years is my estimate.”
Even once power is in place and permitting and entitlements processes have all been completed, growing data center construction timelines are also slowing the pace at which new data center capacity is being delivered. Industry insiders point to supply chain delays as well as a shortage of specialty labor needed for large-scale data center projects.
“You used to be able to build a data center in six to 12 months. Now it’s 14 to 18 months in a best-case scenario,” Greenwood said. “That's purely on the construction side, not including the availability of land, entitlement and power and all those things.”
There is a broad consensus that these constraints on large-scale projects are unlikely to ease in the near future. Greenwood said that while smaller deals will prop up overall leasing activity in the months ahead, the huge campus-scale deals that will push leasing up to previous levels will only materialize a few years down the line.
“You'll be able to find six to 10 MW here and there, but if you're talking about 24 to 36 MW or more for building requirements, those are about four-plus years out now,” Greenwood said.