Data center developers have long relied on tax breaks to make projects pencil. But as growing animosity toward the industry leads states and municipalities to roll back data center incentives, developers and tech giants are increasingly preparing to build without them.

Since the start of the data center building boom nearly a decade ago, certain key tax breaks have been considered a required prerequisite for large-scale data center development. These incentives, particularly at the state level, have played an outsized role in determining where billions of dollars of digital infrastructure investment have landed, shaping the geography of the industry’s rapid expansion.

But now, local and state governments across the U.S. are starting to pull back these tax breaks.

Amid a national wave of opposition to data center development — and with the industry becoming a political flashpoint ahead of November’s midterm elections — nearly a dozen states have paused or rolled back their data center tax incentives over the past six months. Counties and municipalities in some of the industry’s most important markets are enacting moratoriums and new restrictions on their own incentives.

Industry leaders, speaking last month at Bisnow's Midwest Data Center Investment Conference & Expo, said losing tax incentives can hurt a market’s competitiveness, but it isn’t necessarily a death sentence for planned data center projects.

While markets without targeted tax breaks may get passed over in the site selection process, sophisticated developers and their Big Tech customers can often find ways to make projects pencil without them. And as more states and counties end incentives or attach new conditions to them, they say the days of tax breaks being a requirement for development may be nearing an end.

“The tax incentives are not the core or the foundation that make or break the project,” said Abhijeet Shrivastava, program manager for global land development strategy at Microsoft. “If you are comparing two sites with the same power and same regulation, then, of course, the incentives will come into play, but it's not the core where because of the incentives a developer would not build a data center.”

In an effort to capture a share of the artificial intelligence building boom, a majority of U.S. states have offered data centers sales-and-use tax exemptions that reduce or eliminate taxes on the billions of dollars of IT hardware housed inside the facilities. For hyperscalers like Amazon, Microsoft and Google, these exemptions can be worth hundreds of millions of dollars at a single site.

The enormous value of these tax breaks has effectively made them a prerequisite for hyperscale development, with tech giant end users reluctant to lease or build facilities in states where they aren’t available. As data centers emerged from obscurity to become commercial real estate's fastest-growing sector, the number of states offering these incentives jumped from just seven in 2009 to 27 in 2017 and 38 by April of this year.

Additionally, many counties and municipalities offered incentives of their own, most commonly property tax abatements negotiated project by project. These local tax breaks helped spark the emergence of some of the industry’s most important hotbeds throughout states like Georgia and Texas.

The past six months have seen a sudden reversal of that trend.

Between May and August, Maine, Minnesota and Nebraska repealed their data center tax breaks, while Arizona, Illinois, Massachusetts, New Jersey and Ohio paused their programs. A handful of other states — including Pennsylvania, Delaware and North Carolina — stopped short of eliminating their incentives but narrowed eligibility or attached more restrictive conditions for receiving them.

Local governments have also begun rolling back their incentives. In August, Georgia's Fulton County Board of Commissioners passed a resolution opposing any new tax abatements or other financial incentives for data centers and urging the county’s development authority to stop considering them. In Florida, Brevard County commissioners voted to exclude data centers from a local property tax abatement program.

Such measures could become more widespread. An Ohio state representative introduced a bill last month that would prohibit local governments statewide from granting property tax abatements for data centers.

This sudden retreat from data center tax incentives is occurring amid a broader wave of local, state and federal measures aimed at limiting data center development. Industry insiders say it’s no coincidence that this is happening during the run-up to midterm elections in which data centers have emerged as a prominent issue in key races across the U.S., prompting lawmakers from both parties to distance themselves from an industry facing growing backlash over power costs and other community impacts.

Fair or not, DICE panelists said the industry has entered a new reality in which the incentives that were in place at the beginning of a project might disappear during the development process. Developers need to plan accordingly, they say, and assess whether a project will still be financeable without the incentives in place.

“These tax incentives are politically driven, so that means there are communities involved, there's a lot of emotions involved, and they're not guaranteed,” Schneider Electric account manager Axel Kretschmer said at the event, held at the Loews Chicago O'Hare Hotel. “It shifts the focus onto other finance segments. Is this project without the tax incentives financially viable?”

There is little question that losing state or local tax incentives can put projects at risk, panelists said. Hyperscalers still strongly prefer states with sales-and-use tax exemptions, and developers seeking those companies as tenants face a much tougher road if an expected exemption disappears.

The stakes for developers are on display in Colorado. While the state has many of the ingredients for a major data center market, it has seen little large-scale development in part because it lacks a targeted incentive for the sector.

At the local level, the loss of property tax abatements also undermines a project’s economics. The projected cost increases can change the financing equation — boosting capital requirements, tightening margins and forcing developers to scramble to find places to cut costs elsewhere in the budget — and send developers back to the drawing board.

“You have to drive the savings somewhere else in the project if that's where you're underwriting to,” said Maria Poyer, principal for strategic programs and global expansion at CoreWeave.

However, panelists said losing tax breaks isn't necessarily fatal for a data center project. In some cases, they say, it can help separate viable projects from more speculative proposals in a region’s development pipeline. Projects backed by experienced developers with hyperscale tenants and strong underlying economics are in a better position to absorb the loss of a tax break. Weaker projects are more likely to be abandoned.

This separation of the wheat from the chaff ultimately favors the industry’s well-established, experienced developers, panelists said.

“It limits the highly speculative projects from becoming fruitful, and it really brings forward those that are well-founded, that have a good business case behind them and that have a good partnership behind them,” Kretschmer said.

Hyperscalers are also becoming less rigid about tax incentives. Poyer said developers were traditionally pushed by the major cloud providers to build only in markets with incentives in place.

Now, she says: “We’re seeing that less and less.”

Microsoft, in particular, has increasingly eschewed incentives. The company announced in January that it would no longer seek reductions in local property taxes for new data centers and has since pushed to exit previously approved abatements in Georgia.

While Microsoft’s policy only applies to local incentives, Shrivastava said tax incentives in general no longer top the list of site selection criteria for hyperscalers.

“They help with the economics of the project. They help with the financial, the ROI of the project and the timeline of the project, but the core is still that you have the land and you have the power,” Shrivastava said. “If you have those, then the incentives just help to make the area more competitive.”