Data center as an investment niche for real estate investors

The COVID-19 pandemic has accelerated many trends and caused severe problems for several usage types of buildings. In particular, the rise of e-commerce, home office, and homeschooling have advanced the digital transformation and increased the demand for data center capacity. But what are data centers, what do they comprise, and do they count as real estate or rather as infrastructure?

From a real estate perspective, a data center (DC) is a highly specialized operator property with a lot of technology that is needed to run the servers. This includes a redundant, high-performance power supply, which is required both for the servers themselves but also to cool down the heat they release. Redundancy aims to eliminate downtime. If the user is a so-called colocation center with multiple users and not a large corporation with the appropriate know-how and capacity, it needs a competent operator to manage the DC infrastructure.
Even before the pandemic, strong growth in DC capacities was predicted despite miniaturization.

Data volumes have been growing exponentially for years and will continue to do so in the future. Among the influencing factors that will continue to increase the future demand for DC are cloud solutions, 5G, and the associated applications such as autonomous driving. The spread of 5G, in particular, requires many smaller DCs (also known as EDGE centers) to be distributed throughout the country in order to guarantee low latency. The demand for and lettability of a modern DC will therefore be given in the long term.

Demanding operator real estate 

However, so far data centers have (still) only received marginal interest from institutional investors, at least in the DACH region. One of the probable reasons for this is structure. The required technology is hardly manageable for real estate investors. Additionally, technical equipment drives the costs for a modern data center, in any case, to over 10,000 EUR/m2 of DC space, and often even easily reaches 20,000 EUR/m2.

The building envelope accounts for only 20% or less of this. Moreover, air-conditioning technology, in particular, is subject to faster change and wear and must thus be replaced more frequently. As such, investors from outside the field are largely dependent on the operator’s know-how.
Another unique feature of data centers is that their rental contracts are concluded on a kilowatt basis and not on an m2 basis. While this takes some getting used to for real estate professionals, it can still be converted to m2.

Here’s how the investment market looks

Big tech companies, such as Google, Facebook, and Microsoft, usually have their own hyperscale centers built by others, then buy and operate them themselves. What’s more interesting though is the market for so-called colocation centers, which consist of several 1,000 m2 of DC space and in which several tenants, some of them very small, rent partial space. This rental space ranges from suites (several 100 m2) and caches (parts of suites) to individual racks.
There are a number of carrier-independent operators, but most of them also own the DC. The global leaders include, for example, Equinix, Digital Realty, and NTT (with its German subsidiary e-shelter) as well as Interxtion and Telehouse. Equinix and Digital Realty are also global REITs that have been raising investor money for many years. Another global REIT is Keppel from Singapore which recently entered the German market with a DC from Maincubes.

The German market is only at the beginning 

However, a lot is happening in terms of transparency. Various conference providers have begun focusing on the topic and interest is growing. The expected wave of investment in smaller EDGE centers reduces the ticket size and thus the cluster risk. In addition, institutional money that was previously invested in bonds, shopping malls, and hotels is looking for alternatives – and will certainly find some of them in data centers. One thing is for sure, the market will develop.