BlackSwan Zine

By Randyl Drummer for CoStar Group

Companies may have slashed many business expenses over the last few years — planned expansions, employee headcounts, benefits and travel budgets, among others — but the need for speed and power in computing networks and communication, and a corresponding investment in IT infrastructure, has skyrocketed right through the recession.

In one decade, increasing Internet throughputs and hunger for bandwidth has taken us from an era of 56K dialup modems to FiOS connections and computer drives capable of storing 1or 2 terabytes of data and even more on the virtual Internet “cloud” via such companies as Google, Microsoft and Apple. And that’s just talking about your home office and gaming room computers.

The business need for Internet speed is also rising exponentially in the digital era of Google, Yahoo, Netflix, YouTube, Facebook, Twitter, online gaming and smart phones. Such “cloud” data must be stored offsite at colossal data and collocation centers — facilities housing computers, servers, telecommunications and storage equipment, and systems to backup and protect data, power and cooling systems.

Like the broader high-tech sector powering it, the wholesale and enterprise data center property niche has been one of the few commercial real estate sectors to generate sizzle through the recession.

Granted, like most other asset categories, data center sales, leasing and development transactions slowed considerably in 2008 and 2009 as construction and acquisition financing dried up. However, pent-up demand since at least 2005 has sparked a new flurry of construction, acquisitions and equity raising activity this year by data center builders and investors, with hundreds of thousands of square feet of new data center facilities announced in the last few weeks alone, according to transactions tracked by CoStar Group, which also spoke to some of the leading commercial real estate experts in the field, which stands along with medical office buildings as the leading CRE niches today.

“There’s three or four times the demand than current supply. If you needed to sign a lease and move into 50,000 square feet in a 7- megawatt facility tomorrow, there’s probably only three options in the whole country,” said Jim Kerrigan, director of the Grubb & Ellis National Data Center Group based in Chicago.

“I see a lot more interest in development and in activity and leasing. There’s just all kinds of activity,” added Michael Siteman, executive vice president, leading mission critical solutions in Southern California for Jones Lang LaSalle. “Investors are seeing this as one sector that’s continuing to grow. With the jobless recovery we’re seeing, companies are making investments in infrastructure and the segments of their business that support their growth.”

“The demand is there and most of the developers buying land or planning developments are very, very sensitive to that demand,” Siteman said. “They keep a real tight pulse on the marketplace. The reality is there just aren’t that many opportunities for rapid delivery of high-power space that’s required.”

Discussions of data center demand start with a central fact: most facilities built within the last decade have either maxed out their capacity or have become obsolete as a result of changing technology, and those changes have begat the need for new development. In the last five years, power capacity has eclipsed square foot as the primary unit measurement for data centers. Revenue and return on investment is tied to a facility’s available power, its cost, and the square footage under roof to host a customer’s — or multiple customers’ – equipment and data.

The changes that are roiling corporate IT and data center strategies drew the spotlight in last week’s blockbuster restructuring announcement by Hewlett-Packard Co., the world’s largest maker of personal computers. HP said it plans to take a $1 billion charge to automate its data centers network and make other changes in its IT platforms to ramp up cloud computing.

A decade ago, the largest data center operators and tenants were the phone companies. But as e-commerce emerged during the dot-com bubble of the late ‘90s, major companies like Yahoo, AOL, Microsoft, Apple and the fledgling Google, Inc., and hundreds of startups, began building and occupying their own data, IT and collocation facilities. A new industry of owners and specialized builders of wholesale data centers and shell buildings rose to meet the new demand.

The bursting of the dot-com bubble in March 2000 did not much slow the growth of the Internet, though it did tamp down the growth of data centers for a few years. However, data center design, construction and operation grew rapidly in sophistication during the mid-2000s, with several companies going public as REITs, including Equinix Inc. (Nasdaq: EQIX) and Savvis, Inc. in 2000, Digital Realty Trust (NYSE: DLR) in 2004, Dupont Fabros Technology (NYSE: DFT) in 2007 and a number of others in both the private and public markets.

The pace of acquisitions and development has accelerated this year. In addition to HP’s plans to massively restructure, consolidate and automate its commercial enterprise data centers and networks, companies have announced data center deals almost daily throughout the spring.

“I don’t know if it’s a boom, but cloud computing is definitely shaping how data centers build out their new sites from the power and infrastructure standpoint,” said Shane E. Quivey, vice president, Colliers International San Francisco. “A lot of the recent flurry of development activity is attributable to cloud computing, and to the ever increasing demand of content delivery.”

Facebook recently moved into a turnkey facility and they’re almost at capacity, Quivey said. And it’s not just social networking companies driving demand; it’s content deliverers like Netflix and online gaming such as Xbox 360 Live.

“The gaming industry is a very serious vertical, especially in the wholesale data center and collocation space,” Quivey said. “You can’t build these data center sites with enough security and power to satiate these growing businesses.”

Digital Realty Becomes Dominant Player

San Francisco-based Digital Realty Trust has emerged as perhaps the leading player in the space over the last year. DLR has been on a tear, unleashing a torrent of new acquisitions and development projects over the last few weeks. In April, the company said it would complete 170,000 square feet of turn-key data center space in five markets by the end of June, including projects in Dallas, San Francisco, Northern Virginia, Northern New Jersey and London. DLR further announced it will build out existing projects in Dallas, Boston, Chicago, St. Louis, MO; and Charlotte, NC.

However, Digital Realty’s announced its biggest deal of the year last week, a $725 million purchase of the prominent (and long marketed) Rockwell Capital/360 Main portfolio made up of five properties in Arizona, California and Virginia. Digital Realty bought the 919,000-square-foot portfolio from joint ventures that are majority owned by affiliates of Rockwood Capital and managed by 365 Main, Inc.

The properties, all less than 10 years old and located in strategic data center markets, include 365 Main Street in San Francisco; 2260 East El Segundo Boulevard in El Segundo, CA, 720 2nd Street in Oakland, CA, 2121 South Price Road in Chandler, AZ and 4030-4050 Lafayette Center Drive in Chantilly, VA. The deal includes 250,000 square feet of new development space at the Arizona asset and uninstalled infrastructure improvements.

Michael F. Foust, CEO of Digital Realty Trust, said the Rockwell portfolio is leased to a diverse roster of over 200 tenants in various industries.

“The addition of these high-quality, mission-critical data center facilities to our operating portfolio will further extend our leadership position as the largest wholesale data center provider in the U.S.,” Foust said.

On May 10, Digital Realty announced the acquisition of a 40,300-square-foot shell building near several existing data centers in Santa Clara, CA, in the heart of Northern California’s Silicon Valley, for development of two raised-floors, 1,125-kilowatt data center spaces totaling about 25,500 square feet, to be delivered to the market by the end of the year. Little more than a week ago, Digital Realty added to its Santa Clara holdings, acquiring two shell buildings totaling 82,000 square feet that will support development of another six finished data center spaces. The space will start coming on line by early next year.

Development is just hitting its stride and over the next year, there’s likely to be a buildup of 100 megawatts of available data center space totaling roughly north of 250,000 square feet in Silicon Valley, said Jerry R. Reich, Jr., Managing Director, Critical Environments/Facilities for CB Richard Ellis in Washington, D.C.

Nationwide, mandates that the health care industry go digital, assisted by government funding, are expected to help drive the market for new collocation facilities aimed at smaller and mid-cap medical users, said Reich, who is helping Cleveland Clinics build a data center in Ohio.

Also late last month, DLR cut the ribbon on a $488 million project to redevelop a former telecom site near Dallas into a huge seven-building data center campus with the potential for as much as 800,000 square feet of space. Last week, the REIT announced the acquisition of two shell buildings totaling 82,000 square feet in Santa Clara that will support development of another six finished data center spaces totaling 48,000 square feet, which will start coming on line by early next year.

The acquisitions, all located on a 4.2 acre parcel near Digital Realty’s Space Park campus, will create economies of scale allowing the company to incrementally build out and deliver data center space in Santa Clara to expand its footprint and meet the strong demand in supply-constrained Silicon Valley for data center product, said Scott Peterson, senior vice president of acquisitions for Digital Realty Trust.

In other significant projects tracked by CoStar Group:

• Data Foundry, a provider of wholesale and retail data center outsourcing, collocation and disaster recovery services, announced a new 250,000 -square-foot master-planned data center on 12 acres in Austin, TX. The $150 million project, the first data center built in Austin in a decade, is expected to deliver in second-quarter 2011. Austin remains a sought-after location for data centers due to its reputation as a technology cluster, a track record of few natural disasters and cost-effective power source.

  The project also underscores the reality that data center operators often decide to build new facilities to meet their immense power needs rather than redevelop existing sites. After an extensive search to find a suitable facility in Austin, “it became clear that retrofitting an existing building would not allow us to deliver the high level of service that we envision for our new data center, so we have chosen to build from the ground up,” said Ed Henigin, Chief Technology Officer of Data Foundry, founded in 1994 as San Antonio’s first internet service provider (ISP). The company operates data centers in Austin and Houston and owns private networks in Austin, Houston, San Antonio and Dallas.

• Denver-based data center and peering provider CoreSite announced it had fully leased the first phase of its Santa Clara data center campus at 2901 Coronado to a single private data center tenant. Maintaining secrecy is paramount in the high-stakes tech wars and CoreSite would describe the tenant only as “one of the world’s largest technology companies, headquartered in the Bay Area.” CoreSite’s portfolio contains a tangible development position in the strategic Santa Clara data center market, with an additional 12.6 acres and a site plan for 446,250 square feet of data center space.
• Data center provider Terremark Worldwide announced in late May that it launched a new data center at its NAP of the Capital Region campus in Culpeper, VA, 70 miles from Washington, D.C., and acquired an additional 27 acres for future development to target federal government agencies in the quarter ended March 31.
• American Express late last month confirmed plans to locate a $400 million data center in Guilford County, NC. AmEx has data centers in Phoenix and Minneapolis and a credit-card call center operation in Greensboro, NC.
• Stream Data Centers this spring began construction on a 20,000-square-foot data center in Richardson, TX, a suburb of Dallas. The single-story, structurally enhanced building contains 10,000 square feet of 36-inch raised floor data center space with dual feed power from separate substations, 175 watts per square foot of critical load, and a four-generator mechanical backup configuration. The data center will be available for occupancy in August and can be either divided into four quadrants or controlled by a single tenant.

Data Center Capital: In the Game, No Longer on the Sidelines

Investor interest in data center assets has heightened as inventory has filled, with several experienced operators launching IPOs or selling shares to raise development and construction capital.

“There’s a substantial amount of money being invested into the space, ranging from private equity firms to high-net-worth individuals to pension funds to publicly traded companies,” said Grubb & Ellis’s Kerrigan. “I get a call every day of the week from someone who wants to turn their bowling alley into a data center.”

“It’s not like we’re seeing all these new players coming into the market — the money is going straight to the guys that have a proven track record. The challenge is that data centers are so costly to build that it’s almost impossible to raise that kind of cash without looking to the public markets,” added Kerrigan, who recently placed $100 million on behalf of the electrical workers pension with a data center developer.

And some of those operators with proven track records are turning to the public markets.

Tampa, FL-based Validus Group announced plans March 23 for a $1.5 billion initial public offering (IPO), partnering with Carter & Associates of Atlanta to create the Carter Validus Mission Critical REIT Inc., according to a prospectus filed with the U.S. Securities and Exchange Commission. The non-publicly traded trust will buy medical facilities, data centers and educational facilities, and possibly secured debt.

In May, CoreSite, formerly CRG West, filed for an initial public offering (IPO), expecting to raise $230 million. DuPont Fabros Technology Inc. said last month it launched a sale of 11 million shares to raise more than $300 million to fund construction of wholesale data centers in Santa Clara and Ashburn, VA .

“Data centers are the cornerstone of an emerging communication services industry and the technology real estate class. Demand for quality built ‘scalable’ data centers is at a high level due to favorable market trends,” Carter Validus said in its filing. While computer processor size has sharply decreased, overall processing capacity requirements have exploded and as a result, the supply of data center space is deeply constrained.

“Money’s no longer on the sidelines, it’s very much in the game,” said CBRE’s Reich. “Data centers are even stronger than medical office buildings because the upside is so tremendous; it’s a relatively short fuse on ROI.”

Current data center designs contemplate changes in space needs, but more importantly, also include future power demand metrics. Changes in health care technology and data center needs also are expected to drive a need for space near medical facilities. Many companies and government entities prefer and often require a single-tenant configuration to need clients’ security needs.

Operators acknowledge, however, that the same factors creating those opportunities for developers — rapidly changing technology, evolving industry standards, frequent new service introductions, shifting distribution channels and changing tenant demands – could also end up being risks to investors down the road.

For example, in the due diligence section of its prospectus, Carter Validus Mission Critical REIT Inc said the data center infrastructure in some of the data centers it will acquire could become obsolete due to development of new server technology and systems to deliver power to or eliminate heat from servers. The power and cooling systems in data centers are difficult and expensive to upgrade without passing the cost to customers.

[costar.com]