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All industries and professions have their own language: recognising and using it (appropriately) demonstrates membership of the club. The commercial real estate (CRE) world is no different. If you spend enough time at one of the well-worn property watering holes in London's West End, you’ll be treated to new terms from the property vanguard as they enter the CRE lexicon. Often, these are repackaged older concepts, as well-worn as those watering-holes, but sometimes, there is a genuine innovation - a new alternative asset class is "invented" through innovation or a technical breakthrough. Data centres are exactly one such innovation that have proven to be a remarkably resilient investment asset class.
I recently spoke with Oscar Matthews, Associate Director of EMEA Data Centre Capital Markets at CBRE, to get the low-down on this specialist sector and see how it’s holding up in today's turbulent environment.
Harry Iles: Hello Oscar, easy starter – what are data centres? What shapes and sizes do they come in and where can we find most of them?
Oscar Matthews: A data centre is a physical room, building or facility that houses IT infrastructure, such as computer servers, for building, running, and delivering applications and services, and for storing and managing the data associated with those applications and services. The “cloud” is actually physically located within buildings in various locations around the world. They can range anywhere from a small section of an office floor (a few 1,000 sq. ft.) to millions of sq. ft. in vast warehouses. They are generally found in and around major cities, given that these are where the majority of data is being created.
HI: How long have they been around and how does the property industry view them from an investment perspective?
OM: The first data centres emerged during World War II, with the development of early computers used for code-breaking and scientific calculations. They were large, room-sized machines that required significant power and cooling infrastructure. The invention of the World Wide Web in the late 1980s/early 1990s marked the beginning of the Internet era. This led to the growth of web hosting services and the establishment of large-scale data centres to support the increasing demand for internet services. The 2000s saw the emergence of cloud computing, with companies like Amazon, Google, and Microsoft offering software-as-a-service (SaaS), infrastructure-as-a-service (IaaS) and platform-as-a-service (PaaS) solutions - further increasing data centre demand and growth. From an investment perspective, it is probably one of the least well-known real estate sectors and consequently has been dominated by investors who are familiar with it. The majority of data centres are owner-occupied: the percentage of value represented by the real estate is small, so it makes sense for an operator to have 100% control and also own the land and buildings. This has traditionally put real estate investors off; however, one exception is UK-listed real estate investment trust Segro plc, which owns 32 data centres on the Slough trading estate, the second-largest hub of data centres in the world: proof that there are exceptions to the rule.
HI: How easy is it to invest in them?
OM: Given my previous point, there are very few traditional real estate investment transactions for data centres across Europe, which average around seven per year. The M&A market is far more active with a huge influx of private equity money coming into the sector. If you acquire a data centre platform, you instantly have existing sites, a management team and scope for growth.
HI: What are the pitfalls to avoid - are they vulnerable to technical innovation? Do they risk becoming quickly obsolete?
OM: The technical advances within the sector are rapidly evolving, with computers becoming more powerful, requiring new cooling methods and new modular designs. These all assist in data centres becoming more efficient. The cost of maintaining and replacing the infrastructure required to run these data centres is so high, that some legacy facilities may become obsolete with customers requiring specific sustainability targets - preventing them from renting space from some of the older assets.
HI: From what I understand they consume a lot of energy, how is the sector overcoming this hurdle especially as countries and companies are committing to Net Zero by 2030 or 2050?
OM: They do indeed use a lot of energy, there is no denying that, but they are also essential infrastructure for the digitalisation of the world’s economies. The demand for data centres has increased significantly since the Covid-19 pandemic, with flexible working and online meeting applications, such as Zoom and Microsoft Teams, driving internet usage. There is the Climate Neutral Data Centre Pact, where a large number of operators have committed to becoming carbon-neutral by 2030. The sector is very much in the spotlight because of its energy consumption; however, operators are doing everything possible to make facilities more sustainable. Especially as customers are becoming far more attuned when choosing providers - given that it will affect their own carbon footprint. Many data centre operators are already adopting renewable energy sources as a way to reduce their carbon footprint, as well as implementing water-efficient technologies and using recycled water, which can reduce their water usage and corresponding environmental impact.
HI: How are data centres investments performing in the current environment?
OM: The main impacts affecting the data centre sector are construction price inflation and the huge rise in the cost of energy. Having had a fairly static period of rental growth for the past few years, we are now seeing rental values increase to reflect the additional costs for the landlord. From a real estate investment perspective, despite strong sector fundamentals (continued demand, low vacancy rates and strong take-up levels) we saw yields shift by ca. 150bps-200bps since the start of 2022 driven by increased interest rates. There is still a huge demand from investors to enter the space, but the opportunities are few and far between, suggesting that the data centre sector is slightly more robust to recessionary periods than other more traditional sectors.
HI: What does the future of data centres look like?
OM: Today, data centres are evolving to incorporate artificial intelligence, machine learning, and automation to improve efficiency and reduce human intervention. The deployment of 5G networks is expected to drive further growth in demand for real-time data processing and low-latency services, enabling new applications such as autonomous vehicles and smart cities. Data centres will continue to be housed in warehouse structures and require significant power supply, but new technologies such as liquid immersion cooling (storing servers in a liquid) will become more mainstream once more operators start adopting the technology. Green data centres will continue to gain prominence, focusing on energy efficiency and reducing the environmental impact of data centre operations. Industry standards and guidelines have been developed to promote sustainability in the data centre sector. These standards focus on energy efficiency, renewable energy use, water conservation, waste reduction, and other sustainable practices. By following these standards and best practices, data centres can ensure that they are operating in an environmentally responsible manner.
HI: Oscar, thank you for your insights.
OM: It has been a pleasure.