New Investors Boost Construction, Competition in Data Center Sector

ASHBURN, Va. – The rapid growth of cloud computing has attracted new types of investors in the data center industry, who are eager to capitalize on the sector’s success. These new investors are creating new companies to compete for cloud business, and investing in data center construction in leading markets.

This new class of investors in the data center sector, including infrastructure funds and sovereign wealth funds with deep pockets and extended time horizons. Their activity has been scaling up over several years, but 2019 is the year where their impact will be felt, according to panelists at last week’s CAPRE 2019 Data Center Forecast East in Ashburn, Va.

“I think there’s been a transition from being a private equity industry to an infrastructure fund industry,” said Fentress Boyse, who is with the Private Infrastructure team at Partners Group. Access to the right capital is incredibly critical. I work in an infrastructure fund, and there’s a great appetite for data centers. I think in 2019 you will see a lot of infrastructure capital deployed.”

“There’s a lot of money looking to get into this space,” agreed Emil Sayegh, the CEO of Hostway, which recently acquired Hosting.com.

For many years, private equity firms have been the leading investors in the data center industry, acquiring service providers and properties and providing capital to support their growth. Private equity firms typically have a timeline (often five to seven years) in which they seek to realize a return on their investment through an exit via a sale or IPO.

Infrastructure funds, which traditionally have invested in projects like airports and toll roads, tend to have longer timelines for return on investment than private equity funds, which have been the prime movers in data center investing. The industry has also seen interest from sovereign wealth funds – state-owned entities with deep pockets – as well as wealth management firms that aggregate funds from affluent families.

January featured the launch of two new companies, both created from existing portfolios. Evoque Data Center Solutions is a new colocation player formed through the purchase of 31 data centers from AT&T, with backing from Brookfield Infrastructure Partners. STACK Infrastructure launched a new brand with assets acquired from Infomart and T5 Data Centers, and the backing of IPI Data Center Partners.

Major Projects in the Pipeline

The impact of these new funds is being seen in Northern Virginia, the world’s largest data center market and a focal point for cloud computing infrastructure. Companies backed by new investors in the industry have announced plans for four new data center campuses in “Data Center Alley” in Ashburn, which over time may bring as much as 600 megawatts of new wholesale data center capacity to the local market. Here’s a look at these projects:

• Vantage Data Centers is using capital from owner Digital Bridge to enter the Ashburn market, building a 142-megawatt campus. The first building is expected to come online this spring.
• Cologix, which was acquired by infrastructure firm Stonepeak Infrastructure Partners, has announced plans for a 100-megawatt campus in Ashburn, where it will redevelop the current site of the Christian Fellowship Church.
• Aligned Energy has begun construction on a planned 180-megawatt campus in Ashburn, enabled by a “significant” strategic investment from Macquarie Infrastructure Partners.
• EdgeCore Internet Real Estate has announced plans for a 144 megawatt campus in Sterling. EdgeCore’s backers include GIC, GIC, the sovereign wealth fund for the government of Singapore.

Analysts are interested in how the entrance of these well-heeled private players will impact the market in Northern Virginia, where publicly-held data center REITs (real estate investment trusts) like Digital Realty, Equinix, CyrusOne and CoreSite are among the leader players. Panelists at CAPRE noted that that the Ashburn market has recently absorbed wholesale data center space at an astonishing rate, with a record 270 megawatts of leasing in 2018. Much of the new capacity in Data Center Alley is pre-leased, with cloud platforms occupying the space almost as quickly as it can be built.

Will Competition Squeeze Returns?

Location is a major factor, according to Paul Himes, President and CEO of Himes Associates.

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“Why does new capital want to build in Ashburn?” said Himes. “Because it’s (address is) Main and Main. If a sovereign wealth fund is looking to deploy capital, it’s comfortable in Ashburn and will accept a lower return to build.”

Indeed, a key question is whether large deals and more private players will mean lower returns for data center developers. Data center REITs have historically had stronger returns on capital than REITs in other assets classes like office and shopping center properties. Competitive pressures from private players could narrow margins over time.

“The stock market has been used to those (strong REIT) returns,” said Boyse. “I think some of the pricing pressure and increased competition argues for private markets and patient capital, and having a capital partner with a long-term horizon.”

“I think some of the pricing pressure and increased competition argues for private markets and patient capital, and having a capital partner with a long-term horizon.”
Fentress Boyse, Partners Group

Executives at public players say they are used to the competition, and can maintain margins by continuing to improve the efficiency of their operations.

“The larger hyperscale deals have a lower price point than the enterprise deals,” said Stuart Dyer, Business Development Manager for CyrusOne. “If we keep our build costs low, we can mitigate those.”

On Tuesday’s earnings call, Digital Realty CEO William Stein expressed confidence about the company’s ability to compete with new private players in Ashburn.

“What I have observed in that the private guys win deals when Digital Realty doesn’t have inventory in the market,” said Stein. “It’s a question of availability. I do think we are the preferred provider for most of the hyperscale players.”

“If the hyperscale players have to choose between a private provider with whom they’ve done little to no business, and Digital with whom they’ve done a substantial amount of business, it’s been our experience that they would prefer to do business with the provider that offers the shortest cycle for providing a product,” Stein added. “That has to do with reliable construction deliveries and knowing that the building is going to operate as expected.”

Public REITs, Private Money Team on JVs

Several of the public data center REITs are seeking to partner with investors on new construction. Equinix is looking to fund some of the projects in its Hyperscale Infrastructure Team through joint ventures that capitalize on strong investor interest in the sector, while providing Equinix with more flexibility with its balance sheet. The company is taking time to find the right JV partner, which is not a surprise for CAPRE panelists.

“Having the right (JV) partner is critical,” said Boyse. “You want to find a partner who can grow with you.”

The structure of joint ventures can be complex, as the data center REITs seek capital support, but typically control the details of the project.

“I’m not sure how many investors are willing to cede control and not have a say how assets are managed,” said Himes.

What’s clear is that investors are growing comfortable with the cloud infrastructure sector. “Data centers are now a core part of the asset mix,” said Andrew Gold, a principal with Datacenters Unlimited Management.”

That’s a function of the industry’s dynamic growth, compared to other investment options

“It’s important to see what is driving the growth,” said Himes. “If you look at the underlying fundamentals, it’s not going away.

“Capital is desperately looking for yield right now,” Himes added. “Capital will pour into this industry.”