The Rise of the Build-to-Suit Cloud Data Center

Cloud computing is changing data center development, with action now shifting to a build-to-suit model in which cloud builders pre-lease entire buildings for themselves, representing 12 megawatts or more of new capacity. Wholesale data center providers, who have previously built multi-tenant buildings and leased them one data hall at a time, are adapting their model to accommodate the build-to-suit demand.

In the latest example, CyrusOne has just acquired a building in Northern Virginia, which has already been fully leased to a hyperscale data center customer. The 130,000 square foot building will provide 12 megawatts of IT capacity for the fast-growing cloud provider.

“Within just over a month, we were able to quickly identify a solution and purchase a new shell building within a highly constrained market,” said Kevin Timmons, Chief Technology Officer for CyrusOne.

It’s the latest in a series of recent “super-wholesale” deals where tenants have leased between 16 and 22 megawatts of space, some of the largest leases in the history of the multi-tenant data center industry. Several major cloud platforms are seeking even bigger deals of 25 megawatts or more, according to a recent report from Jim Kerrigan of North American Data Centers.

Trend With Benefits for REITs

It’s a trend with benefits for the publicly-held data center REITs (real estate investment trusts), who are positioned to do larger deals to construct data centers that are pre-leased, which are less risky and easier to finance.

“We are seeing a significant change in customer buying behavior, as more and more Internet scale companies are approaching us to do build-to-suit projects for them,” said Gary Wojtaszek, CEO of CyrusOne, which has been perhaps the leading beneficiary of this trend. “About 95 percent of our capital this year is being allocated towards pre-sold projects, which is the highest level we’ve ever had. This is like just a phenomenal position to be in.

“I think industry-wide, this is probably the highest point of capital towards pre-sold deals ever,” he added “It’s a really good data point for the (data center REIT) industry.”

The focal point for the build-to-suit boom is Northern Virginia, where large cloud players like Microsoft and Oracle are said to be seeking large amounts of leased data center space. Data center providers and REITs have been aggressively buying up land around Loudoun County’s “Data Center Alley” in Ashburn over the last year, a trend that may soon expand to Prince William County as sites grow scarce in Loudoun.

“Last year, there were 63 megawatts worth of capacity secured in (Northern Virginia) alone,” noted Christopher Eldredge, the CEO of DuPont Fabros Technology. “There’s so much growth out there with the hyperscale cloud providers. We’re at the very early stages in that game.”

Microsoft, Oracle Gobble Up Capacity

In a build-to-suit project, the developer works closely with a single tenant to customize a building for their needs. The build-to-suit model has been used for years in the data center sector, primarily for tenants the financial industry or government sector. Russo Development has built multiple build-to-suit projects for Wall Street customers, while Compass has provided smaller custom solutions for service providers. Digital Realty and QTS Data Centers have teams that focus on build-to-suit opportunities.

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But the growth of cloud has given greater prominence to build-to-suit projects, and taken them to a new scale. As we’ve previously noted, the cloud computing arms race is accelerating, and the battle will be waged with data centers. The leading players are moving quickly to amass capacity for the clouds to come, resulting in huge deals for data center space under development.

The DuPont Fabros Technology SC1 data center in Santa Clara, where a tenant recently leased the entire 16-megawatt third phase of the project. (Photo: DuPont Fabros Technology)

After years in which the cloud boom was driven by developers, startups and “cloud native” companies, enterprise companies are beginning a more serious adoption of cloud services. This is reflected in the surge in demand from Microsoft and Oracle, two huge companies that built their businesses on the sale of on-premises software licenses. As they shift to a cloud delivery model, both companies are migrating their existing customers to cloud services – effectively moving workloads off servers in enterprise data centers and onto servers in cloud data centers.

“Our database customers want to move their application into our cloud, putting their database onto our platform as a service and then their applications,” said Oracle Chairman Larry Ellison on the company’s earnings call. “There’s huge demand for it.”

As this process accelerates, Microsoft and Oracle must add capacity in a hurry. To accelerate their expansion, they are working with wholesale data center developers who specialize in rapid provisioning of new cloud capacity. Until recently, that has meant leasing available turn-key data halls or serving as anchor tenants, lining up several data halls in projects that are under construction.

A Slow Shift to Enterprise

The “big four” cloud providers – Amazon, Microsoft, Google and IBM – grew by 68 percent over the past year, according to August data from Synergy Research Group. This growth could continue for some time if enterprise adoption accelerates. Data center executives cite growing evidence that this shift has begun in earnest.

“What you see with Amazon’s growth, Microsoft’s growth, Oracle’s recent acquisition of NetSuite is that these guys are on a rocketship ride,” said Wojtaszek. “They are  seeing an incredible shift from enterprise customers and are trying to meet that capacity as quickly as they can. I think we’re in the early stages here of a trend that’s going to go on for several years.”

“There have been several recent announcements of cloud adoptions that we believe support our strategy,” said Eldredge. “GE is moving the vast majority of their leased and owned data centers into the public cloud. Johnson & Johnson announced in July that it expects to have 85 percent of its applications running in the public cloud by 2018.”

“Gartner predicts that by 2018, 30 percent of enterprises will use cloud service providers direct when cloud connectivity services up from less than 1 percent at the end of last year,” said William Stein, the CEO at Digital Realty. “We believe it’s still early days for cloud adoption and the related build-out of cloud service providers’ compute node footprints. From where we sit, it looks like the wave of cloud service provider demand has not crested yet. And we see a wave building on the horizon from the Internet of Things and connected devices.”

Speed-to-Market Boosts Case for Leasing

One factor in this growth is a change in the decisions driving the “build or buy” equation. Companies that have historically built their own data centers have shifted to a leasing strategy, buying turn-key IT space from developers that specialize in data center construction.

CyrusOne built this 30-megawatt data center in Sterling, Virginia in just six months to meet the timetable of a large cloud provider. (Photo: YouTube)

CyrusOne says it has won build-to-suit business based on its ability to bring new space to market quickly. Earlier this year it completed its Sterling II facility, a fully pre-leased 30 megawatt data center in Northern Virginia, in just six months.

“They know that we can deliver within a really short time frame,” said Wojtaszek. “Even if they have a really volatile forecast, they know that we can deliver capacity and meet their needs and make sure that they can provide the services that they’re going to sell their customers. They absolutely know now that we can do something special, that they can’t even do for themselves because we can do it so much quicker.”

Other providers are also focused on rapid delivery of data center buildings. “We’re working hard to bring products to market as quickly as possible,” said Eldredge, the CEO of DuPont Fabros. “We know it’s important. We’ve identified some improvements in our design and in our process which is going to help us deliver product to market a lot quicker.”

Some Remain Cautious on Rates, Sustainability

CyrusOne and DuPont Fabros have been the leading beneficiaries of the trend, while Digital Realty and CoreSite have also won major cloud deals that filled entire buildings. Private developers are also said to be in the hunt for cloud-scale built-to-suit deals, including RagingWire, T5, Cloud HQ and Sabey Data Centers.

Analysts have expressed concern that this competition will lead to pricing pressure on super-wholesale deals. Some industry executives share that concern.

“The competitive environment is strong, especially for the hyperscale opportunities that are 3.5 megawatts and above,” said Stein, the CEO of Digital Realty. “With the competitive bids, it does put a certain amount of power in these cloud service providers’ hands.”

Other industry executives wonder whether the recent activity represents a new normal for data center demand, or might be a short-term phenomenon as cloud players  seek to catch up with Amazon. Among those is Tom Ray, the outgoing CEO of CoreSite, who expressed a note of caution on the company’s recent earnings call.

“If some of the hyperscale cloud guys have a full belly at the moment and slow down for a little while, and that’s not backfilled in the next 12 months by other uses at that same volume, then I think supply may get a little out in front of take-up and we’ll see some softening,” said Ray.

It’s also possible that the focus on large cloud deals will complicate the data center REITs’ ability to provision their traditional product of data center suites.

“While leasing large amounts of power capacity to one user is a positive for the data center operator, it can also create challenges in accommodating additional demand from existing or new customers in that market,” notes David Liggitt at DatacenterHawk.