Data Centers: What Investors Need to Know

Once a niche slice of real estate portfolios, data centers are becoming an increasingly important segment. The sudden rise since the pandemic of cloud-based technologies that support remote work, streaming services and the Internet of Things has triggered this rapid growth. Artificial intelligence is further fueling the expansion. 

“In just the last 12 months, there’s been a surge in the market because of AI,” says Jim Kerrigan, founder of North American Data Centers.

The high interest rates of recent years have done little to stem the growth of the industry. “There are very few investment sectors that are not sensitive to recessions, but data centers may be one,” says William Pattison, Head of Research and Strategy at MetLife Investment Management. 

The industry measures its growth by the power it consumes, rather than by the square footage it occupies. And by that yardstick, it will grow by 160% worldwide by 2030, estimates Goldman Sachs.

But data centers might not be a slam dunk for investors. Because while AI is creating new opportunities for institutional investors, the blinding speed at which technology is moving is presenting unique challenges for data center investing.

Because the types of data centers are so varied, they may offer diverse opportunities for real estate investors.

While hyperscale data centers are typically leased to a single tenant, colocation data centers are often occupied by multiple tenants who share operational costs. The two data center types present different risk profiles. Leases for colocation centers are typically shorter, which may be preferred given current market conditions. 

Hyperscale data centers, meanwhile, “offer potentially lower targeted returns and income yields—but also potentially lower risk,” says Pattison. Leased by some of the world’s largest—and most profitable—companies, such as Amazon Web Services, Microsoft and Google, hyperscale tenants typically boast excellent credit.

The data center business is also expanding beyond its historical geographic strongholds. In prior years, companies have vied to lease space at data centers in primary markets like Northern Virginia, whose proximity to fiber-optic cables and energy infrastructure has helped make it the data center capital of the world, according to datacenterHawk.

However, notes Pattison, latency—the delay in transmission of data between devices and servers—has become less of a critical factor in determining data center location.

“The calculus has been changing,” he says. “Video streaming was a big driver of data center expansion, and one where end-users expect low latency. As that’s changing to AI, latency can be sacrificed or at least deprioritized. Some of the fastest-growing data center locations today are simply those with inexpensive electricity and shorter lead times for commissioned power.”

Demand is spilling into secondary and up-and-coming markets like Iowa, Indiana and Mississippi, where Amazon is planning a $10 billion project that includes data centers and solar generation sites.

”Anybody who has any significant source of power has now become a new data center market,” says Kerrigan.

But from an investor’s perspective, there can be danger in a data center’s technological half-life. “We believe the biggest risk is quantum computing,” says Pattison. “If quantum data storage and quantum processing becomes a commercially viable, scalable product in the coming decades, then there could be obsolescence in data centers.”

A single data center doing the work of 100—or 1,000—data centers would be a game changer for the industry, Pattison says.

Data centers are likely to continue to have a place in institutional investors’ portfolios, even when the next recession comes, says Andy Lawrence, a founding member and Executive Director of Research at the Uptime Institute, an industry advisory group. “I don’t believe any industry is recession-proof, but the data center market didn’t skip a beat during Covid,” he says. “AI just took it to the next level, and the AI wave is not over.”

The Uptime Institute projects that by 2025, AI will surge to 10% of the sector’s global power use, up from 2% today. 

But institutional investors must be prepared to react to other technological waves—like quantum computing. “We believe there’s a 25% chance that quantum computing will become commercially viable by the end of the 2030s,” says Pattison. “These exponential growth curves in supply and demand are what I lose sleep over.”

There is one certainty: Data will continue to be generated at an explosive pace. Today, the total amount of data created, captured, copied and consumed in the world is estimated to be 115 zettabytes. That figure is projected to reach 175 ZB—52% higher—by 2025¹. 

For the foreseeable future, at least, the demand—and challenges—for data centers will continue to grow in an increasingly digital world.

¹The world’s data explained: how much we’re producing and where it’s all stored (theconversation.com) May 4, 2021