How the West Was ‘Tier 1’

Andrew Schaap, CEO at Aligned, takes a deep dive into Tier 1 cities for data center development, and how the evolution of Tier 1, 2, and 3 locations is changing the market. 

As businesses worldwide accelerate their digital transformation initiatives, data center development today is fundamentally different and far more sophisticated in nature than it was during the dot-com boom era. At that time, the main driver for data center site location was connectivity, and the building between 1999 and 2002 was focused primarily on the major internet markets, especially New York, Northern Virginia, Silicon Valley, Chicago and Dallas, where a critical mass of customers and fiber resided. In time, data center providers expanded their facilities across the U.S. in so-called Tier 1, or “NFL” cities.

Today, however, it’s not only Tier 1 cities that are driving the digital economy, but Tier 2 and Tier 3 locations. Yes, the core markets will always be the core markets, but there are tremendous opportunities for data center growth in emerging markets, and not just in the U.S., but also in Europe and LATAM. Interestingly enough, the population base of Tier 2 markets in Europe is generally smaller than Tier 1 markets individually, but many are close to Tier 1 markets in data usage, economic activity and geographic size. Moreover, there are 124 Tier 2 cities in Europe that make up nearly 80% of the entire continent’s metropolitan urban population.

This is noteworthy because a similar trend has emerged in the U.S., as a recent study by Redfin predicts that the expansion of the remote workforce in the wake of the pandemic will drive a seismic demographic shift toward smaller American cities. One of every two respondents surveyed stated that they would consider moving out of large metro areas if they were able to work remotely all the time.

The New Guns in the Data Center Market

Undoubtedly, the global health crisis is contributing to a shift in the data center industry from core markets to sites that may have been considered Tier 2 or Tier 3 only a short time ago, and coinciding with the rise in demand of online services, including streaming content, video conferencing and cloud collaboration platforms, social media and online gaming. Just three to four years ago, for example, Salt Lake City was considered a Tier 2, perhaps even a Tier 3 market. Today, we’re witnessing a flurry of large enterprises and hyperscalers deploying infrastructure there. Because of the spike in demand for online services and the impact of latency in the region, it’s no longer realistic to serve the Salt Lake City market from Los Angeles.

Known as the Silicon Slopes, the Salt Lake City area is a growing technology hub with extensive fiber infrastructure and some of the fastest internet speeds in the Intermountain West. As a desirable colocation market, the State of Utah enjoys some of the lowest electricity and natural gas rates in the nation, and renewable energy sources such as solar and wind are also rapidly growing. Additionally, Utah is classified as a cold desert; hence, its low humidity levels enable data centers to employ ambient cooling techniques, reducing cooling costs.

But the main reason why Salt Lake City is an attractive data center market is that it offers some of best tax incentives in the country. In Utah, qualified data center owners, operators and customers are exempt from sales tax on purchases of data center equipment with an economic life of at least one year that is used in their operations. These flexible tax incentives do not call for specific requirements around lease term, provisioned capacity, capital investment or job creation. Overall, Utah is aggressively pro-business, with a corporate income tax rate of only 4.95%. While no one can predict the future, the rate at which companies are expanding and digitalizing services to meet the rising demand from their own customers will require data center providers to be extremely nimble in building, solving problems and scaling.

Especially as compared to the West Coast and Pacific Northwest data center markets such as Santa Clara and Hillsboro, Salt Lake City is neither overly saturated nor cost prohibitive. Not only is there room for new data center builds and expansions, but Salt Lake does not suffer from the soaring land values prevalent in Santa Clara area, nor the region’s unfortunate risk factors that include climate exposure and water scarcity, traits it shares with Hillsboro.

Salt Lake City also possesses a highly capable workforce. A U.S. News & World Report study found that Utah has the second most educated population in the nation. The city’s quality of life and cultural richness are renown, and within a short drive, the world class skiing and snowboarding isn’t bad either.

In fact, given the growth trends — including Facebook’s Eagle Mountain data center as well as the launch of Google Cloud Platform in the region, which provides customers added flexibility to distribute their workloads across the Western U.S., including existing cloud regions in Los Angeles and Oregon — it’s reasonable to anticipate that the Salt Lake City data center market may even double in size over the next 24 to 36 months. Indeed, there are several other Tier 2 and Tier 3 markets across the country with similar growth trajectories, including Denver, and Reno, Nevada, which in time will likely follow this same arc.

While no one can predict the future, the rate at which companies are expanding and digitalizing services to meet the rising demand from their own customers will require data center providers to be extremely nimble in building, solving problems and scaling. Hyperscalers and large enterprises present a sophisticated clientele, and in some cases, these customers have already sourced their land, power and even alternative energy sources in advance of their strategic expansions.

Serving these types of companies might call for a more flexible deal structure, or identifying unique markets or regions that might not be so obvious today, but will become critical in the near future. Just take a look at Phoenix, a market that is now witnessing a tremendous amount of activity and which one could argue is on the cusp of becoming Tier 1.

To meet the demands of organizations’ accelerated digital transformation and expansion in Tier 2 and Tier 3 markets also necessitates access to stable capital and a standardized supply chain. While the West may have once been predominantly Tier 1, Tier 2 and Tier 3 cities are fast becoming the new guns in the global data center market, both domestically and abroad. Hence, working with the right design and build partner that can help companies cost-effectively scale with the requisite speed-to-market needed to thrive and remain competitive has never been more critical.

Andrew Schaap is the CEO at Aligned .