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A Whole New Ballgame: Data Center Investment 'More Like A Cricket Match That Lasts For Days'

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Data center real estate performance has grown by 250% over the last five years, and investors and analysts say the wave of money and demand in the sector has made investment nearly foolproof.

Deutsche Bank's Andrew Bartrop, Guggenheim Securities' Matt Bissonette, GI Parnters' Rahul Chandiok, Newmark Knight Frank's Miles Loo Jr., Redbird Capital's Robert Covington, Goldman Sachs' Jeff Ferry and Safanad's Brett Owen
Safanad's Brett Owen, Deutsche Bank's Andrew Bartrop, GI Partners' Rahul Chandiok, Newmark Knight Frank's Miles Loo Jr., Redbird Capital's Robert Covington, Goldman Sachs' Jeff Ferry and Guggenheim Securities' Matt Bissonette

When panelists were asked at Bisnow's Data Center Investment Conference and Expo in Manhattan last week the classic real estate investment cycle analogy — what inning of the game are we in — Goldman Sachs Vice President Jeff Ferry said when it comes to comparing investing in data center real estate against other asset classes, they are playing different sports.

"I think it’s more like a cricket match that lasts for days and days and days," he said. "We’re in the first day, and it just goes on and on."

That is the general consensus among those buying into the data center space, where even developers who build risky, speculative properties without much experience or expertise are seeing their bets pay off.

"There are plenty of examples of not only equity building, but also debt funding of construction of spec builds, which is probably, maybe, the forewarning of overbuilding," Ferry said. "Because growth keeps chasing it, people get saved from maybe wrong analysis and improper use of capital, only because the growth of the industry is chasing it and propelling it."

The growth and projected future demand is undeniable. Cowen & Co. Managing Director and Senior Research Analyst Colby Synesael opened the full-day conference with a presentation on the state of the data center market. He projected that on-site data storage, currently at 77% of the industry, will drop to 43% by 2022, leading to a huge surge in data center demand.

An engineer at Amazon Web Services predicted that the company would need three data centers in 1,000 regions around the world long term, Synesael said. While AWS is the biggest driver of data center space, it is still just one company, and its projection of need could set the tone for breathtaking demand in the future.

"Granted, not every company is going to need that level of capacity, but it really starts to open one's eyes to the opportunity set that still remains in front of us," he said.

Cowen & Co. Managing Director and Senior Research Analyst Colby Synesael speaks at DICE Northeast, July 26, 2018.
Cowen & Co. Managing Director and Senior Research Analyst Colby Synesael speaks at DICE Northeast, July 26, 2018.

The push for more, bigger data centers in more places — companies like Microsoft, Apple and Facebook are called hyperscale tenants and are driving an increasingly large share of the market — is attracting investors of all shapes and sizes, more than ever before. Hyperscale represented about 28% of third-party data center revenue last year, Synesael said, citing Structure Research data. Five years from now, that is expected to grow to 59%.

In dollars and cents, hyperscale data centers generated $30.8B of revenue last year. By 2022, it is projected to balloon to a $224.4B industry. No wonder institutions like Brookfield, which bought AT&T's data center portfolio in January, and international funds are increasingly looking to place money in the asset class.

"There is a healthy number of new entrants looking to lend in the space. There’s been innovation and borrowers have more options to choose from," Deutsche Bank Managing Director Andrew Bartrop said. "I think the backdrop feels like there’s a lot to continue to create demand in the space, with 5G, just generally the move off-premise, which has still got a lot of room to run. We think the sector’s going to continue to run for a number of years."

The oncoming tidal wave of 5G, along with edge computing, was of particular note because of how they will fundamentally change location dynamics. The closer data centers are to their users, the more powerful the speed will be. For cellphones, Synesael expects 5G marketing to start hitting in full force as soon as this year or 2019. 

More powerful for data center investors will be the reduction of latency and increased use of the Internet of Things that 5G will enable. Rather than the 80-second latency users currently experience at 4G, 5G will feel instantaneous, according to Synesael.

"If you’re in real estate and you put on your cool Google Glasses and you have a real estate application that allows you to look at a building, it’s going to be able to tell you in real time, with no latency, that that building is owned by XYZ company, it was last sold in 2010 at this price on a per-SF basis," he said. 

"Said differently, the cloud is going to be a very key aspect of 5G and making it work. 5G is the first generational technology being built with cloud technology in mind from the beginning. So when you hear about edge computing, that cloud solution, that content, that storage, that has to happen much closer to that end user who’s using that Google Glasses has been, historically speaking. That’s why the edge, or 5G is going to drive significant demand toward the edge when 5G really does come to fruition."

Intermedia's Jonathan Levine, Maxco Supply's Nabeel Mahmood, DappsInc.s Vikal Kapoor, QTS' David McCall, WebAir's Sagi Brody, Element Critical's Jason Green and Intel's Melvin Greer
Intermedia's Jonathan Levine, Maxco Supply's Nabeel Mahmood, DappsInc.'s Vikal Kapoor, QTS' David McCall, WebAir's Sagi Brody, Element Critical's Jason Green and Intel's Melvin Greer

That proximity requirement is why AWS wants 100 megawatts of capacity in 1,000 regions eventually. The hyperscale users will be the big winners as more technology shifts to the cloud and more users demand 5G.

"We need it faster, it’s got to happen quicker, it’s got to be stronger," Element Critical Chief Technology Officer Jason Green said. "Fundamentally, you need edge, you need to be as close to the humans as you can possibly be."

The question, then, is how does the data center real estate industry capitalize on that? The answer is scale. Over the last year and a half, more than nine mergers and acquisitions have taken place worth more than $100M, including the landmark merger of Dupont Fabros and Digital Realty for $7.6B

While the U.S. data center market is more mature, much of that scale is going to be realized internationally, panelists said. There are Brazilian and South African data center builders currently on the market, and U.S. companies are angling to gobble them up, Synesael said.

"One of the trends you’re seeing is global, and that’s largely driven by customers," Safanad Vice President of Private Equity and Real Estate Brett Owen said. "This is a global business, from a customer standpoint. They like, if they have an operator they like, to see them deliver a comparable product internationally, and that’s driven a lot of the growth outside the U.S. I think that’s going to continue."