Tag Greason, chief hyperscale officer at QTS Data Centers, has been in the business for more than 20 years, but he still sees the sector as at the start of its trajectory. “Every January I think to myself, as I set my goals, we are just at the beginning of this industry,” he says.

This is set to be a banner year for data centres in North America, following a spate of take-privates touched off by Blackstone’s acquisition of multi-tenant facility provider QTS last year. Leasing activity in the US was “unprecedented” in the first half of 2022, according to property services firm JLL, and the construction pipeline exceeded the total for all of last year, with 1,913MW.

When Blackstone bought QTS for $10 billion, the firm was acting on “one of our highest-conviction investment themes” in digital infrastructure, says senior managing director Greg Blank. Since Blackstone Infrastructure Partners has a permanent capital fund, it can buy a business as a platform and “provide them incremental capital to really turbocharge their growth over the next decades, not years”. Surging demand for data, as well as outsourcing to offsite data centres, is “a multi-decade theme”.

That conviction is shared by KKR, which followed in Blackstone’s footsteps when it took CyrusOne private with Global Infrastructure Partners. Waldemar Szlezak, partner on KKR’s infrastructure team, says that data centres represent “generational investment growth opportunity”, with numerous desirable qualities: “high barriers to entry, mission-critical infrastructure, long-term contracts, high-quality counterparties, low churn and highly predictable cashflow streams.”

There is also “very limited technology risk” in the case of wholesale or hyperscale operations. “The demand side is really encouraging,” Szlezak says. “For a long time, the industry was talking about deflationary pressure, in terms of yields.”

That dynamic has been reversed by factors including rising costs of materials, labour and capital, as well as supply-chain disruptions. “Investors like the opportunity to deploy capital and see those very attractive yields. There are fewer and fewer global data centre platforms capable of doing that.”

Infrastructure investors “need a large, growing sector to deploy capital”, agrees Brent Burnett, managing director and head of real assets at Hamilton Lane. In the recent past, managers have put between 30 percent and 40 percent, or more, of their fund capital in the midstream energy sector in North America, but many have lately pivoted towards data and telecoms: “This was formerly typically 5-15 percent of a diversified infrastructure fund; now it’s about 30 percent.”

Data centres in particular can absorb a lot of investment. “It’s a very capex-intensive asset base,” Burnett explains. “If you think about a typical data centre, a 500,000- to 700,000-square-foot hyperscale facility, at $1,000 per gross square foot that’s anywhere from $5 million to $12 million dollars per megawatt, or $500 million to $700 million of capital.”

While investment interest will continue to be driven by “the fundamental need for more data centres globally, but particularly here in North America”, Burnett says penetration in the US is high, and lease rates are coming down. “Yields are a little better in Europe. Any time you see a higher yield for a similar asset, you’ll see capital flow there.”

A new financing paradigm

Though M&A activity in the sector was picking up in the years before Blackstone’s deal, with notable investments by Digital Realty and Equinix, the acquisition of QTS featured innovative financing that showed how a large data centre company could be taken private. “The universe of debt investors who finance these businesses has moved from the traditional leveraged-finance world used in private equity and infrastructure transactions,” Blank explains.

“There are crossover elements between real estate and infrastructure in data centres. Finding investors from the real estate side who recognise the power of these trends opened up the aperture to provide effectively a higher amount of leverage, but at much more flexible and lower rates.”

“We’ve started seeing an ongoing evolution of the financeability of this asset class,” Szlezak confirms, including “forms of real estate/asset-backed longer-term/higher LTV financing”. Other dominoes that have fallen alongside QTS and CyrusOne include CoreSite, acquired by strategic buyer American Tower for $10.1 billion, and Switch, bought by DigitalBridge for $11 billion.

“There’s an ongoing expansion into secondary and
tertiary markets”

Waldemar Szlezak

Areas of interest

Though hyperscale computing is a far cry from the early days of network connectivity, the origins of the internet in the 1960s are still evident in the data centre industry’s geography. When the Department of Defense decided to create a continent-wide communications network that could withstand a nuclear attack, “the East Coast node was established in a sleepy town called Ashburn, Virginia, 30 miles outside of Washington, DC”, Greason recounts, “all farmland”. He is based in that same town, where so much of the country’s data centre capacity resides today.

While ARPANET’s West Coast node in the Bay Area gave rise to Silicon Valley, one of the country’s most expensive enclaves, Northern Virginia remained affordable, with cheap land and power and available workers. The result was “unfettered growth of that East Coast node”, Greason says, which continues: Northern Virginia led the US in data centre construction in H1 2022, with 1,010MW, JLL reports – more than half the national total.

With such phenomenal growth in a built-out market, signs of strain are starting to appear.

“There’s a little bit of stress in the market in Northern Virginia,” says Dalmar Sheikh, director of global data centre operations at Actis. With their enormous appetite for power, water and land, data centres are highly resource intensive. “There’s still some capacity, but not as much as there used to be. Deployments are too large. There’s a push to shift some of that to Ohio, in the case of Amazon.”

Szlezak says: “There’s an ongoing expansion into secondary and tertiary markets, which over time may become closer to tier-one, as well as strong growth in the core and core-plus markets.” The primary hubs are North Virginia, New York-New Jersey, Atlanta, Dallas-Fort Worth, Chicago, Phoenix, Silicon Valley and Hillsborough, Oregon. Among the rising satellite nodes are Salt Lake City, Denver, Manassas in Virginia, Fayetteville in Georgia and New Albany in Ohio.

Brent Burnett adds Kuna, Idaho, outside Boise, and Waukee, Iowa, near Des Moines, to the list of peripheral places of interest. “Washington is a reasonably hot data centre market,” he says, “with cheap power from renewable or sustainable energy sources. The data centre providers need to get more creative about how they provide that power.”

Going green(er)

The sector is becoming less about space and more about availability of power. Szlezak says: “There have been a few recent reports of potential power availability challenges in Loudon County, North Virginia. You’re starting to see that in other markets as well – Frankfurt, Dublin, Arizona. Over time, this business will continue evolving and efficiencies will be created. But having an ability to provide power – and the more green, renewable power it is, the better – will become much more important.”

“It’s my number one cost item in my P&L,” says Greason. “I am 100 percent motivated to drive efficiencies into power utilisation.”

Improved designs and more focused cooling techniques have allowed the industry to restrain the growth of its energy consumption. “In the olden days, if you walked into a data centre the entire room felt like a meat locker,” he recalls. “Today’s data centre is going to feel like it’s 82 degrees [Fahrenheit].”

The transition to renewable power is being driven in large part by market demand: several of the largest hyperscale customers – Amazon, Google, Facebook, Microsoft – have made commitments to be carbon neutral. “This is, from an ESG perspective, a very good story,” says Blank. “We expect [QTS] to be 100 percent renewable in three years.”

Water conversation is another critical ESG factor. A traditional data centre with an open-loop cooling system uses 1.1 million gallons a day, about the same as a golf course, Greason explains. “Today, all of the QTS data centre new builds – there are four in our fleet that still have to be retrofitted – are in a closed system,” which makes do with 2,000 gallons. “It’s far more effective, but it wasn’t the standard five years ago,” he says. “It’s the standard now.”