Data centres are becoming the hidden stars of the real estate market

The asset class of data centres is growing just as rapidly as the data volumes used worldwide. As such, it harbours enormous potential for alternative real estate investments.

September 18, 2019

Few still doubt the much-cited adage that data is the raw material of the 21st century. Data itself takes up little space, requires no real estate and does not need to be transported on the roads. And yet it is dependent on an elaborate infrastructure: in 2018, some 36.5 billion gigabytes of data made its way through the stationary German internet alone. All of this needs to be managed, stored and controlled somewhere – for instance in data centres, the number of which is multiplying as quickly as data traffic on the internet. For the real estate sector, this presents vast and rapidly growing potential for alternative properties.

Data centres – a strange new world, even for real estate experts

Data centres are special-purpose properties with highly specific building requirements, and the location criteria and market drivers also deviate significantly from those of established real estate such as offices, retail premises and logistics facilities.

Developments such as Industry 4.0, cloud computing, new internet applications and, of course, social media, are bringing about exponential growth in data volumes and data processing. In turn, this is driving demand for data centres in Germany and worldwide. Tentative but noticeable progress is also being made in autonomous driving. This factor will provide a huge boost in demand for these buildings due to the amounts of data which will require processing.

Many factors which only play a minor role in other property types have a significant influence on the real estate value of data centres: access to the power supply, connection to the fibre optic network, proximity to large internet exchange points, security and the reliability of the building’s air conditioning. As such, different criteria must also be considered during the real estate valuation process.

All this is compounded by the fact that data centres are described using language that is unfamiliar to most real estate experts. While rents in commercial real estate are usually described in euros per square metre, or floor space is measured in square metres, the key figures for data centres are completely different – for instance, euros per kilowatt or capacities measured in megawatts. Terms such as latency and data centre types, including colocation or retail, further muddy the waters. Therefore, the key figures are also not comparable to those of “conventional” properties. Moreover, one encounters different users, operators and investment models, and the rental contracts are designed differently to those in the rest of the commercial sector.

Apart from legal matters such as building law or taxes, data centres therefore have very little in common with the region specific traits that are otherwise typical in the respective area. Deep market knowledge that extends beyond borders, as well as technical expertise are required in order to determine the value potential of these properties.

Dynamic real estate market with stable cash flow

Today, the provision of alternative properties is a proven method of optimising real estate portfolios. This allows companies to share in the success of growing market segments, as well as contributing to the diversification of portfolios and minimising investment risks. On top of this, they also allow performance to be optimised in view of the currently low interest rates for established real estate classes.

At the same time, the rapid growth in data volumes will inevitably generate further momentum in the market for data centres. This asset class generally benefits from users with strong credit ratings and long-term yields even for short-term contracts. This is partly due to the fact that it is extremely difficult to relocate IT spaces, and, as a result, lessees make large investments, which strongly binds them to properties and sites. In some cases, they invest several times the pure classic construction costs (cost group 300 and 400) in the user-specific IT infrastructure of their own accord.

Relocations are thus relatively improbable for this and other reasons: the server racks contain highly sensitive data and downtimes have a particularly negative impact in this sector. As a result, the migration of larger facilities is unusual; indeed, it is almost impossible. To perform a migration on a scale of this size would be a mammoth task; virtually all data would have to be duplicated and the system then switched over within milliseconds. Due to this complexity, most large users, at least those with sensitive data, almost never relocate their racks. This particular characteristic contributes to a secure cash flow – a good argument for investors to tap this market.

Still not enough transparency in the data centre transaction market

It should be mentioned, however, that this market still lacks transparency. Numerous transactions are not sufficiently documented: there is not always a clear differentiation between physical structures and IT systems in the transaction figures. Furthermore, many property transactions come about indirectly, i.e. within the scope of the data centre operator’s merger and acquisition activities.

If one considers that real estate normally accounts for 20% of the asset portfolio of classic large companies, it is estimated that CenturyLink’s acquisition of the global operator Level 3 Communications for USD 34 billion in 2017 would have entailed an indirect transfer of real estate assets of around USD 7 billion. This figure illustrates the relevance and potential of this hidden asset class and explains the growing interest on the part of institutional investors. In the summer of 2019, for example, Singapore’s sovereign wealth fund, the GIC, entered into a joint venture with the US-based data centre service provider Equinix with the objective of acquiring and developing six European data centres with a value of more than a billion dollars.

Frankfurt am Main is a good example of the extent to which data centres are quietly determining city infrastructures. When measured by data throughput, the city hosts the largest internet exchange point in the world, the DE-CIX. This was originally established back in 1995 with the objective of efficiently connecting the networks of three providers. Before this, the exchanged data had to take a detour via the United States, costing time and money.

Close to the exchange

DE-CIX has since grown into the most important data hub in the world. The latency, i.e. the reaction time between multiple applications, is an essential factor in banking alongside other sectors and is also dependent on physical distance. As a result, everyone wants to be as close as possible to Frankfurt’s data centre hotspot. More and more megawatts are being planned and built here. Even now, the more than 450 data centres there consume more than 20% of Frankfurt’s electricity – surpassing the city’s airport. Just one of these data centres is estimated to use as much electricity as a town of 30,000 inhabitants.

Article by Honoré Achille Simo and Eric Holfert.

Visit our Expo Real 2019 event to learn about data centers and other alternative investments

Alternative Real Estate Investment – Beyond office, retail, residential and logistics assets

8th October 2019
Hall B2, Room B 21
11:15 am -12:15 pm

Honoré Achille Simo
Senior Director, Client Relations Germany, Valuation & Transaction Advisory
Eric Holfert
Director Valuation & Transaction Advisory