Data Center Construction Surging Amid Supply Constraints in Top Markets

This week Data Center Frontier is highlighting market trend data for 2020. After starting with data center leasing activity, we take a deeper dive into data center construction trends.   

Data center developers are scrambling to add capacity, as this year’s record leasing activity has consumed much of the available supply of server space. Several leading markets are seeing a boom in construction, including projects to deliver inventory that has already been pre-leased to cloud platforms and video service providers.

“This year has been crazy,” said Buddy Rizer, the Executive Director of Economic Development for Loudoun County, Virginia. “We’ve had 26 fast-track (data center construction) projects since March. Normally, we’ll have 15 in an entire year, so that’s more than twice as many projects than ever before.

“We’re looking at over 6 million square feet of new data center space,” said Rizer.

By historic standards, that is an extraordinary amount of new construction, even for Northern Virginia, which is the world’s largest data center market. This is especially true during the COVID-19 pandemic, which creates challenging conditions for construction teams and the supply chain that supports them.

In this case, the pandemic is serving as both an accelerant and an obstacle. In 2020, data center demand has been led hyperscale data center operators like Google, Microsoft, Amazon Web Services and Facebook, who need more capacity to address the societal shift to online activity during the COID-19 pandemic. Leasing surged in the second quarter of 2020 during a 30 percent surge in Internet traffic, with some video conferencing services like Zoom seeing much larger increases in demand.

Largest Markets See Supply Constraints

Northern Virginia is the focal point for new construction, but it is hardly alone. More than 373 megawatts of new wholesale data center construction is underway across major markets in the United States, according to real estate firm CBRE, which forecasts that total data center inventory will grow by 13.8% in 2021.

Others have even higher numbers. Cushman & Wakefield and datacenterHawk estimate Northern Virginia construction projects at 322 megawatts, with Silicon Valley, Chicago and Atlanta all having more than 100 megawatts of active construction projects for 2021.

“Demand in Northern Virginia remains insatiable, with all major players under construction,” said Cushman Managing Director Sean Brady said at a recent CAPRE Media webinar. “That’s a staggering construction number.”

Cushman estimates the vacancy rate in Silicon Valley at about 6 percent, about the same as Northern Virginia, with about 189 megawatts of new construction in the works. Silicon Valley has faced an ongoing shortage of finished data center space due to a dwindling supply of development sites and lengthy approval processes in key data center corridors. That’s why new inventory has been quickly gobbled up by tenants, who often have pre-leased space.

Every large wave of new construction in the data center industry is greeted by concerns about overbuilding. As we’ve often noted at DCF, the industry continues to be haunted by the Ghosts of Oversupply Past. The dot-com bust of 2001-2003 punctured the industry’s Field of Dreams era (“Build it, and they will come”) leading to widespread vacancies and bankruptcies.

That experience prompted a shift to phased construction, with space deployed in smaller chunks to align supply with demand. Providers have been more cautious about speculative projects, seeking anchor tenants before proceeding with new builds.

Many of the new projects are already pre-leased, which eliminates the financial risk of empty space, Digital Realty, which is the largest multi-tenant provider in the Northern Virginia market, has pre-leased 100 percent of its new construction in the region.

Jim Kerrigan of North American Data Centers has tracked the industry through several economic cycles, and regularly challenges assumptions about supply and demand.

“Are there too many people in Northern Virginia right now?” Kerrigan said during the CAPRE event. “We ask this question every year. If you asked the landlords at the beginning of 2020, they would say ‘absolutely yes there’s too many.’ The rental rates had dropped at all time lows. But that oversupply in Northern Virginia corrected itself, really with three tenants – Facebook. TikTok and Microsoft. Some folks just had to be there because they have clients that want them there.”

The ‘Build Versus Buy’ Equation May Shift

Securities analyst Sami Badri, a Senior Equity Analyst at Credit Suisse, tracks the supply/demand balance with a metric called “backlog intensity” that compares a developer’s revenue to its capacity that is leased but not yet delivered. His analysis suggests that leading markets remain in catch-up mode on hyperscale inventory.

“We expect more hyperscale outsourcing projects to begin construction, leading to more data center development projects in top colocation markets where supply is constrained,” Badri writes in a recent market analysis. “Given the size of incoming data center infrastructure (large builds), we believe the scale of projects will take longer to deliver versus prior build cycles that could deliver capacity faster.”

Badri also sees a potential demand boost in the buying patterns of cloud and video platforms, who typically build their own data center campuses in some locations, while leasing space from data centers REITs like Digital Realty or Cloud HQ in other places. He believes that mix may shift due to the accelerating demand during the pandemic. As of early 2020, Badri estimated that between 40% and 60% of all data center space is outsourced to data center developers. “We expect this percent of outsourcing to begin indexing closer to the 60% range in 2H20 and through 2022,” Badri notes.

In a capacity-constrained environment, speed is of the essence. Delivering space quickly is a particular challenge during the pandemic, which is expected to stretch some construction timelines. That will likely benefit data center developers, whose core competency is rapid deployment of server space – rather than search algorithms or social media or dance videos.

Loudoun County has a Fast Track Program that provides priority reviews for economic development projects that have significant impact on the tax base, helping applicants navigate the permitting process. When we wrote about the pandemic building boom in July, there were seven fast-track projects. Since then, an additional 19 projects have sought fast-track approvals in Loudoun County, home to the “Data Center Alley” cloud cluster in Ashburn.

Several of the new projects in Northern Virginia are massive campuses designed for development over years. Two examples:

• Digital Realty plans to build the world’s largest multi-tenant data center campus near Dulles Airport in Northern Virginia. The Digital Dulles campus will create 7.5 million square feet of new data center space in the world’s most active cloud market.
• Amazon Web Services is continuing to expand with a massive data center campus just south of Dulles Airport, which could add up to 2.5 million square feet of cloud computing capacity.

But other projects have moved extremely quickly to bring new space online. Rizer noted a project from QTS Data Centers, which just opened its Shellhorn DC-1 in Ashburn, a 300,000 square foot data center that was completed in one of the shortest build timelines yet in Loudoun.

“The Fast Track Program is designed for just 15 projects, so people are looking incredibly hard all across the county to get these to market,” said Rizer. “It has been just an incredible time to be working with the industry on such an important initiative, when we’ve all made this transition to digital. The way we entertain ourselves, the way we talk with our kids, the way we are learning and the way we’re working … the data center industry has never been more important to our daily lives than it is now. So this has been quite an experience.”

Next: What the surge in demand and construction has meant for pricing and lease terms.