What do a data center and a restaurant have in common?

A shortage of servers!

Wordplay aside, though, they have just about nothing in common. In fact, data centers are wildly different from other types of real estate in a whole lot of ways. In most well-established U.S. cities, you don’t have to look far to find an office or industrial building that is a century old. These commercial real estate sectors have been around for quite a while and are the bread and butter of the industry. They are well understood by those in the business, and even by those outside of it to an extent. After all, many of us work in offices or warehouses and experience those types of properties first-hand.

In a way, you've experienced data centers, too. How do we know? Well, you're reading this article! Data centers underpin the internet infrastructure on which we have come to rely: everything from emails and ecommerce to emerging technological innovations such as artificial intelligence, virtual reality, cloud services, and smart devices that continue to become more advanced and equipped with novel capabilities.

That said, you don't gain much understanding about data centers just by using the Internet, and as the data center industry continues to boom, anyone working in real estate would be wise to take note and understand the ways in which data centers differ from other types of real estate. In this article, we’ll look at just a few of the sectors’ many idiosyncrasies. 

Mega-whats?

Most classes of real estate are focused on people, providing spaces for them to live, work or play. Since space is what the tenant needs and is paying for, we generally quantify leasing in terms of square feet. Equipment in a data center also takes up space, of course, but the most critical limiting factor in a data center’s capacity is the amount of power it can deliver to the electronics. For this reason, data center capacity is typically measured in megawatts (MW), which are a unit of power that basically express how much electricity a facility can deliver instantaneously. For reference, a single megawatt (1,000,000 watts) is roughly equivalent to the power needs of 750 single-family homes, and a modern data center can use tens or even hundreds of megawatts. Lease rates within these buildings will be quoted in terms of dollars per kilowatt (1,000 watts, “kW”), as the tenant is most concerned with reserving the power needed to run its equipment. There are exceptions to this rule that we won’t dive into today, but don’t be surprised if you see “MW” where you are used to seeing “sf”.

What do tenants look for?

The unit of measurement isn’t the only unusual element of data center leasing. Not only are there some unique considerations that don’t pertain to other product types, but several of the critical considerations for office/industrial leasing are almost entirely irrelevant.

For office and industrial tenants, key site-selection criteria will include labor demographics, building amenities, retail, parking, access to roads and public transit, to name a few. The common link between these characteristics is that they create a good experience for workers at the location, which is especially important as companies look to attract productive employees back to workplace in the midst of a tight labor market.

Meanwhile, data centers are mostly full of computer equipment. Whereas a modern office building can house up to thousands of workers, you will only find about 50 people working in a typical modern data center. For that reason, employee-satisfaction considerations like amenities and access take a backseat to data-related considerations such as security, redundancy, connectivity and access to reliable utilities. Given the rate at which the industry is growing, many tenants also look for facilities that could offer them expansion space in the near future.

What makes a good investment?

Since data center tenants consider very different criteria than other types of tenants, it should come as no surprise that data center investors and developers also use a different yardstick when evaluating the merits of a building or development site. Whereas office and industrial buildings need highway access to allow for the flow of people and goods, data centers seek proximity to fiber-optic cables to facilitate the flow of data. All that data is stored and processed on equipment that draws a tremendous amount of power, so access to heavy electrical transmission lines is equally critical.

Data travels very quickly in fiber lines – about 70% the speed of light. Given such speed, it’s not obvious that data centers would need to be anywhere near one another. However, since even a few milliseconds of latency (delay in transmission) can be meaningful for certain applications, rapid communication between facilities can be critical and this has led data centers to develop together in clusters. The largest of these clusters is in Northern Virginia. An estimated 70% of all global internet traffic routes through this market, creating a tremendous gravity that continues to pull in new operators and tenants.

As a market begins to accumulate data centers the way Northern Virginia has, eating up land, water and electricity, residents and local governments may begin to raise concern. Political headwinds can derail a developer’s rezoning/permitting process, so sites that allow data centers as a by-right use are the most attractive due to their certainty of execution. Data centers as an industry are relatively new, so many zoning codes do not specify them as a permitted or prohibited use of property and structures. Even so, there may be regulations in place that implicitly challenge data center development. For example, some zones may have minimum parking requirements that could limit development on a property despite being unnecessary for a data center’s skeleton-crew workforce.

“Could this be a data center?”

As certain real estate sectors continue to suffer from the pandemic and its impact on telework, building conversions are becoming increasingly common. Pivots from the languishing office market to the hotter multifamily sector appear to be rising in frequency. Given the booming fundamentals of the data center market, converting underutilized assets into data centers seems like a no-brainer.

But not so fast.

As the data center industry has matured, most major operators have developed their own design standards to create a consistent and high-quality experience across their portfolios for customers. Following these standards typically necessitates ground-up new developments. Conversions have therefore become less common in the industry, and assets that make sense as retrofits are few and far between. That’s not to say some of those obsolete buildings aren’t sitting on great data center sites, but it’s unlikely that the existing structures can be used. Instead, they’re more likely to be town down and rebuilt from the ground up.

Red flags

Clearly, data centers have some unique and specific needs, but just as important as their must-haves are their deal-breakers. Since most data centers need to be online around the clock (99.999% uptime is considered the standard), several of these deal-breakers have to do with reliability and resiliency. To minimize natural disaster risk, developers will steer clear of the floodplain, storm-prone areas, and even seismic hot-spots to the extent possible. Utility shortages are another potential issue: power-constrained markets like Northern Virginia or drought-prone markets like Phoenix may pose additional challenges (parts of the Phoenix market have even considered a moratorium on data centers to conserve water, as data centers use tremendous volumes of water for cooling). 

Even where utilities are available, high cost can be a deterrent for data centers. Electricity can account for as much as 60-70% of a data center’s total operational cost, so utility rates can make or break an investment. Building data centers in California, especially in Silicon Valley, provides proximity to the robust tech industry located there, but expensive power and water rationing due to droughts are major deterrents.

Tax incentives also play a major role in the cost equation. As of writing, roughly 30 states offer incentives for data center investment, typically in the form of sales/use tax abatements on computer equipment and services. Any state that hasn’t put such incentives in place (California is a prominent example) will be viewed less favorably in site selection.

Do data centers make good neighbors?

These tax incentives raise a question: what’s in it for the local government? After all, data centers don’t employ many residents or offer any public-facing services like other types of real estate. They do, however, cost a ton, and can generate tremendous property tax revenues for a jurisdiction even while receiving the aforementioned sales/use tax abatements. Those revenues will pay for enhancements to public goods like roads and schools, which benefit surrounding communities and create additional jobs.

These public benefits often aren’t enough to avoid pushback from local communities. As we’ve mentioned, data centers use up a huge amount of water and electricity, which naturally makes drought-prone communities more averse to data center developments within their jurisdictions. The cooling systems and generators also produce noise while the facilities themselves are sometimes considered visually unappealing, which makes it difficult to develop data centers near residential areas without some pushback. Heavy transmission lines are not exactly considered beautiful, either, so building them can be just as unpopular with residents as building a data center.

Any questions?

Good neighbors or not, data centers will continue to come online in greater numbers. If we can help you gain a better understanding of the industry and the opportunities it brings, don’t hesitate to reach out.

By the way: if you ever find yourself in a data center, know that it is NOT considered polite to tip the servers. You'll get kicked out.