Data Center Sale-Leaseback Deals On the Rise, Expect More in 2018

The rise of the service provider and the decline of the enterprise data center are intersecting in the sale-leaseback, a real estate strategy that provides benefits for both parties.  Industry executives says 2018 is shaping up as a big year for sale-leaseback deals, due to the increased number of properties available and more service providers embracing the strategy as an attractive way to expand into new markets.

“There’s a lot of sale-leasebacks going on, and a lot of enterprise companies are trying to figure out their strategy,” said Jim Kerrigan, Managing Principal of North American Data Centers, a real estate advisory firm specializing in data centers. “I think we will see a lot of these large sale/leasebacks over the next 18 months.”

The rising number of sale-leasebacks was one of the trends discussed at the recent IMN Fall Forum on Data Centers and Cloud Services in Chicago. It’s a trend that has become more visible throughout 2017.

In a sale-leaseback transaction, an enterprise company sells its data center to a third-party, and then leases the space it needs to operate its existing IT facilities. The buyer, usually an investor or data center service provider, collects the rent and can lease the remaining space.

This type of deal solves a common problem. An enterprise company builds a large data center, assuming its IT operations will grow. It winds up not needing as much space as it expected, due to increased use of virtualization or third-party cloud computing services. As a result, large expanses of expensive data center space sit empty.

A growing number of enterprises are putting their data centers on the market, hoping to get out of the business of owning data center real estate. The number of sale-leaseback transactions is trending higher, but buyers have been selective about these opportunities. Many legacy data centers would require significant infrastructure upgrades to be competitive in the multi-tenant data center market.

Trend May Accelerate in 2018

Industry executives says 2018 is shaping up as a big year for sale-leaseback deals, due to the increased number of properties available and more potential buyers pursuing these types of deals.

“Many companies have a grossly underutilized but technically relevant data center,” said William Meaney, the President and CEO of Iron Mountain. “We are having discussions with large, sophisticated global customers with partially empty data centers serving their applications. We can engage in buying those data centers.”

Iron Mountain recently used sale-leaseback deals to launch an international data center expansion, buying Credit Suisse data centers in London and Singapore. Credit Suisse was using just 4.2 megawatts (MW) of the 14 MWs of capacity at the two sites.

An aerial view of the Ascent data center in Cambridge, Ontario, acquired from an enterprise customer that will remain as a tenant. (Photo: Ascent)

In the most recent sale-leaseback deal, Serverfarm acquired a 153,000 square foot facility in Suwannee, Georgia that had been owned by Advanced Micro Devices (AMD).

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“By using sale/leasebacks we utilize our real estate and operational expertise to liquidate hard assets,” said Avner Papouchado, CEO of Serverfarm. “In other words, we cloudify legacy data centers, and therefore, bring agility to the physical assets in the IT stack. At Serverfarm we believe in long-term partnerships.”

The Evolution of the Sale-Leaseback

The sale-leaseback gained favor as an income strategy for data center investors, and initially was focused on single-tenant transactions. An example is TechCore, a investment venture by  GI Partners that has focused on sale-leasebacks of  fully-leased data centers.

“A few years ago, enterprises were doing sale-leasebacks for the entire facility,” said Miles Loo, Executive VP of the Data Center Solutions Group at Newmark Knight Frank. “Now it seems there’s a trend for a lot of partial sale-leaseback transactions (where the tenant occupies part of the facility)”

One of the biggest players in the sale-leaseback market has been Carter Validus Mission Critical, which bought fully-leased properties from service providers including AT&T, IO, NaviSite, Internap, Atos and Ascent Corp. Carter Validus recently sold a portfolio of data centers for $1.06 billion as it seeks to wrap up its first investment fund, but continues to invest in data centers through its Carter Validus Mission Critical REIT II fund.

At a panel at the IMN event in Chicago, Carter Validus Chief Portfolio Manager Dallas Whitaker described the company’s experience with sale-leaseback transactions.

“Sale-leasebacks are a big part of what we do,” said Whitaker. “They offer an opportunity for us to get a long-term tenant in place. There seem to be a lot of these opportunities entering the market today. We’re starting to see a lot of enterprise users that have overbuilt their infrastructure, found that there’s a lot of attractive ways to diversify their data strategy, and found that having a really expensive enterprise data center sitting on the balance sheet may not make a whole lot of sense. ”

Growth Strategy for Service Providers

This year we have seen more deals that include empty space within a single-tenant facility, providing a server provider acquirer with leasable data center space. Carter Validus, Serverfarm and Iron Mountain are among a growing list of data center providers are using the sale-leaseback to expand their footprint. Here’s a look at some other prominent deals:

• CyrusOne Buys CME Data Center: In one of the most strategic sale-leaseback deals, CyrusOne acquired the CME data center in suburban Chicago for $130 million. CyrusOne has since built out and sold additional data halls within the 430,000 SF facility in Aurora, and is now building an additional 500,000 square foot data center on adjacent land that was included in the deal. Importantly, the CME purchase is building business for CyrusOne within Chicago’s financial ecosystem.
• QTS Acquires Dallas Dallas Data Center: In January, QTS Realty expanded its Dallas footprint, investing $50 million to buy a 260,000 square foot data center in Fort Worth from insurer Health Care Services Corp. The existing building has 8 megawatts of power, but the property can accommodate another 60 MW of capacity.
• Element Critical Enters Northern Virginia Market: Element Critical (formerly Central Colo) CEO Ken Parent likes the sale-leaseback model as an expansion tool. In early 2017 Element Critical acquired the Tyson Technology Center in Vienna for $96 million. The property is 75 percent leased, providing both income and space in the important Northern Virginia market.
• T5 Expands into Chicago Market: T5 Data Centers has acquired a large facility in Elk Grove Village from Forsythe Data Centers, which will continue in place as the anchor tenant. The deal provides T5 with entry into a new market, as well as significant expansion capacity within an existing Tier III data center.
• Ascent Buys Sites in Atlanta, Toronto:  In May, Ascent  acquired a pair of data centers in Atlanta and Waterloo, Ontario through through a sale-leaseback deal with an enterprise seller. The two buildings offer 13 MW of available space, plus expansion capacity.
• Lincoln-Rackhouse Expands Footprint: In May, Lincoln Rackhouse acquired a 5 megawatt data center in Atlanta from Coca-Cola, which will remain as a tenant until it consolidate its remaining IT to other sites.

Real estate executives say the growing number of deals could prompt more enterprises to bring facilities to market.

“If there’s a a healthy appetite for these assets, expect to see more of them come to market over time,” said Jeff West, the Head of Data Center Research (Americas) for CBRE.