A new kind of real asset

Infrastructure and real estate investors are teaming up as a wave of capital washes over the sector, fuelled by a booming digital economy.

In the US, businesses of all types have an increasing need for data storage that is creating investment opportunities, and new partners, for real estate and infrastructure investors.

Data centres – buildings that house the backbone of an economy going digital – are emerging as an attractive real asset in the 21st century. From tech giants to small businesses, information is moving to ‘the cloud’, a seemingly invisible service that stores data and allows access anytime, anywhere. In reality, a business’s information is stored in a very physical place – a “shell” – that requires land titles, permitting, cooling and power.

And with so much digital growth forecasted in the coming years, the market opportunity for data centres seems to be here to stay.

The cloud-managed services market is predicted to grow from $35.5 billion in 2016 to $76.7 billion in 2021, according to a report from financial services firm JLL. A December 2016 report by IBM Market Cloud stated that 90 percent of the world’s stored data had been created in the preceding two years. And in 2017, the North American data-centre market accounted for 60 percent of data storage under construction, which will require about 400MW of power to operate. Four of the five top North American markets, with Toronto being the exception, are in the US, including Las Vegas, Chicago, Dallas and Fort Worth, and Northern Virginia.

Data centres first appeared as real estate plays in the early 2000s, after internet-related investments began rebounding following the dotcom crash. ‘Legacy’ data centres, as they’re called today, were built on top of interconnection points as fibre-optic cables were being laid. Office space was included in these buildings to house tenants that need proximity to large network interconnections. These businesses were mainly software and telecoms companies.

Now, the data-centre market has evolved as businesses across all industries digitise their information, according to Marc Ganzi, chief executive of Digital Bridge, a US-based communications infrastructure company. He described three types of assets.

First, there is a corporate-user data centre, one built for a single enterprise where “nobody enters the premises with the exception of employees”, Ganzi says. The other two – co-location and wholesale facilities – are what’s attracting a lot of capital today, he explains.

Co-location facilities are buildings where portions of a data centre are contracted to retail customers. Wholesale assets, or “hyper-scale” data centres, Ganzi says, are extremely large and built for one or just a few users. These data centres are built for tech giants like Microsoft, Amazon or IBM.

“They’re asset businesses,” Ganzi says, “but they’re asset businesses that have organic growth from all of these mega-trends: cloud computing, live streaming, applications, artificial intelligence, self-driving cars.”

What’s unique about data centre opportunities is the broad interest they’re drawing from real estate and infrastructure investors. How Digital Bridge is approaching this sector is a perfect example of how data centres cross the real estate-infrastructure divide.

Last year, the Los Angeles-based real estate investment trust Colony NorthStar partnered with Digital Bridge to raise money for investments in data centres and cell towers. The vehicle they’re raising has been dubbed a digital infrastructure fund, and Infrastructure Investor reported in April it is expected to hold a final close by 30 June in excess of its $3 billion target.

“There’s a lot of heavy real estate blocking and tackling that goes into a data centre,” especially with new developments, Ganzi explains. Greenfield data centres, which are 50 percent of Digital Bridge’s strategy, require understanding of how to obtain title commitments and permitting.

“On the same token, we’re putting in a physical power plant, massive cooling and back-up cooling, fibre-optic networking and cabling,” he says. “In that respect, it’s infrastructure.”

For institutional investors, the appealing part about data centres is that they are fluid portfolio assets. A data centre investment does require land acquisition, but service contracts are what typically generates the revenue, similar to infrastructure cashflows.

Data centre contracts usually cover a package of services, including for the mechanical infrastructure, the power to operate it, interconnection to other networks, security and overall building maintenance. Typically, smaller enterprise customers go into a ‘retail’ data centre, which would have 3-5 year contracts. A Google or Microsoft would go into ‘wholesale’ data centres, and given the investment they make, tend to sign 5-10-year contracts.

“[Investors] like the stickiness of customers. Most of these leases are not only being renewed, they’re getting expanded,” Ganzi says.

Hugh O’Reilly, chief executive of the $19.2 billion OPTrust, says he’s “comfortable” data centres will generate returns that fit within the Canadian pension’s infrastructure benchmark.

In February, OPTrust partnered with GIC, Singapore’s sovereign wealth fund, to invest $800 million in a new data centre-focused company, EdgeCore Internet Real Estate. At the time, O’Reilly said the investment was made from the pension’s infrastructure bucket, but members of its real estate team also worked on the deal.

“As the innovation economy emerges and its disruption becomes more of a thing in terms of how we address investments, I think traditional asset categories are also going to be disrupted and fall away,” O’Reilly argues. “The categorisation of asset classes is going to be less important as the new economy becomes more of a reality.”

WINDOW OF OPPORTUNITY

The amount of capital entering the data centre sector is leading to consolidation over the past three-to-five years, according to Ganzi.

Larry Braithwaite, portfolio manager of ASB Real Estate Investments’ $7.4 billion open-ended Allegiance Fund, says it was this window of opportunity that led his firm to divest its data centre portfolio earlier this year. In April, ASB agreed to sell the iconic Dallas Infomart, one of the legacy data centres that included 1.6 million square feet of data centre and office space, to Equinix, one of the sector’s largest developers and operators, for $800 million in cash and debt securities. Earlier this year, the firm sold its other three data centres to IPI Data Center Partners Management.

Braithwaite says ASB’s decision to sell “was not a reflection of weakness in the sector”, but right timing and “a dearth of competent property managers willing to take on the assignment of the property management and leasing needs we had”.

In 2017, after a search for a strategic partner to scale and manage the platform did not yield results, Braithwaite says ASB put the portfolio up for sale.

Despite exiting the data centre portfolio, Braithwaite says ASB is still interested in the sector and would invest again should an attractive opportunity present itself, even one that doesn’t have office space.

“Data centres are going to continue to become more of a mainstream asset. Capital formation will continue to be strong,” he explains. “Like most attractive investments, that current cash income is what you hang your hat on from a risk-adjusted perspective. I think data centres certainly provide that.”