There's No New Supply For The Little Guy As Data Center Rents Soar
Leasing space in a data center has suddenly become much more expensive, a shift that reflects some of the industry's most pressing challenges.
Data center rents have shot up over the past 12 months, with prices rising close to 20% in some markets.
The industrywide increases come after almost a decade of declining rents, and even higher rates are expected in the months ahead. For tenants, these higher rents come on top of spiking energy prices — in most cases paid by the tenant — that are already driving up IT operating costs.
The sharp increases are due in part to global inflationary pressures and rising construction costs, which are forcing operators to raise prices in order to remain competitive. But experts suggest that the changing pricing dynamics are driven primarily by a growing imbalance between a tightening development pipeline of new supply and demand for data center space that continues to surge.
“The spread is due to market dynamics,” said Ali Greenwood, executive director of Cushman & Wakefield’s data center group. “The tighter the vacancy rate in a market and longer the pipeline for new supply coming online, the higher the potential increase/premium over our all-time-low rental rates.”
In primary North American data center markets, the cost of leasing 500 kilowatts of IT capacity jumped by 14.5% in 2022, according to a February CBRE report.
This figure, while focused specifically on small leases, is reflective of pricing increases across nearly all segments of the data center sector, from retail colocation leases of less than a megawatt to single-tenant, built-to-suit contracts, experts say. Greenwood pegged marketwide rental rate increases at between 10% and 20% over the past nine months and expects prices to continue to rise for at least the next year.
Beyond rising base rents, data center operators are also writing larger annual rent escalations into contracts with tenants. While high-credit tenants previously saw annual increases of less than 3%, or perhaps no increase at all, operators are now looking to bump those annual escalators up to 4% or more to ensure rents keep pace with the inflating consumer price index.
“Now more than ever, those CPI-linked escalators are top of mind,” said Gordon Dolven, research director at CBRE’s Americas data center practice. “That helps mitigate some of the inflation risk at play.”
So what’s driving up data center pricing?
Inflationary pressures are a big part of the picture, particularly the growing cost of building data centers. Data center construction costs are at an all-time high, according to CBRE, driven by rising energy costs and increasingly expensive construction materials.
Supply chain constraints are also continuing to make building data centers more expensive. According to data from Cushman & Wakefield, construction cost estimates jumped from around $9M per megawatt at the beginning of 2022 to around $12M today.
But it isn't just the growing price tag of new development. Industry insiders say operators face growing costs when it comes to maintaining their existing capacity. Those costs are being passed along to tenants.
“While U.S. energy prices have not increased as meaningfully as they have in Europe, global operators are passing through costs to U.S. clients,” CBRE wrote in its North America Data Center Trends report, released last month. “This is impacting national pricing of new renewals and new leasing. Increases in cost across power, labor and equipment are a primary concern.”
But the largest factor driving up prices is a supply-demand imbalance that is being exacerbated by growing challenges when it comes to bringing new data center product to market, experts say. The combination of record demand and supply constraints means that any available space demands a significant premium.
As Bisnow has reported previously, some of the data center sector’s most important markets are facing shortages of buildable land with access to the enormous amounts of power data centers need. Data center projects are also taking longer to complete, held up by delayed power delivery by utilities, supply chain-induced construction slowdowns, and longer, more difficult entitlements processes, among other factors.
All this has been exacerbated by the fact that many of the new data centers or even whole campuses built out over the past year had already been pre-leased by major cloud providers like Microsoft, Amazon Web Services and Google — the so-called hyperscalers — often before construction had even begun. This has left precious little new capacity for every other segment of the market served by colocation providers.
“In 2022, in some markets, providers or operators that were starting construction or had land bank positions for development pre-leased entire buildings or campuses to hyperscalers,” Greenwood said. “It was at a velocity and scale our asset class had not yet seen. We have had pre-leased buildings or build-to-suits before, but not at the volume we had in 2022, and also not typically in such a pre-construction phase.”
The supply environment is so tight that tenants have been left considering leases on buildings that might not be completed for years.
“It’s hard to fathom that leases are being contemplated for buildings that might not deliver for three or more years, but it’s accurate,” Greenwood said.
The experts who spoke with Bisnow said they don't believe rising rents will suppress demand for data center space in any meaningful way. Indeed, data center leasing rose 40% last year, sending vacancy to record lows, according to CBRE. And CBRE’s Dolven said that while average rents are up, average prices are still below what they were as recently as 2015.
Some data center operators are better positioned to control costs and therefore are better able to be competitive on pricing, experts say. Companies that have been better able to mitigate their exposure to rising prices through economies of scale and strong supply chain relationships and contracts are at an advantage, as are companies that have been able to develop new capacity without exposure to higher interest rates, either because projects were financed prior to rate hikes or through creative financing vehicles.
There has also been something of a flight to quality amid rising rates. The industry has seen a wider spread of rental rates over the past year, as newer, highly connected facilities with network connections to cloud providers command huge premiums while operators of facilities just a decade old are finding it harder to raise prices.
“All data center space is not created equal,” said Pat Lynch, senior managing director of CBRE’s Americas data center practice. “Older facilities that have a lower power density and don't have great connectivity would fall outside of the pricing numbers that we're seeing. But in the current environment, there's still demand for that kind of space because of the supply challenges. There’s not a good alternative.”