Our digital lives drive a brick-and-mortar boom in data centers

The shift to digital work and play from home, hastened by the pandemic, has wreaked havoc on commercial real estate. But experts believe it has also generated one surprising bright spot for the industry: data centers.

The growing reliance on cloud-based technology — and the big, blocky buildings that house its hardware — has created greater opportunities for developers and investors as businesses and consumers gobble up more data in a world that has become increasingly connected.

"Our houses are connected, our cars are connected, our streetlights and parking meters are connected, and every single one of those connections is passing data back and forth," said Sean O'Hara, president of the exchange-traded funds division at Pacer Financial, an investment advisory firm in Malvern, Pa.

And companies that provide data storage are preparing for even greater demand as new technologies like 5G and artificial intelligence become more widely used.

"Our business has continued to grow through the pandemic," said Nelson Fonseca, chief executive of Cyxtera, a company that owns 62 data centers across the United States and in five markets in Europe and Asia. "It actually accelerated all the drivers that were growing the industry in the first place."

Fonseca said Cyxtera, which typically leases space in its centers for three-year contracts, was on the hunt for new markets.

"We're seeing demand across the board," he said. "Our pipeline going into 2021 is even larger."

"Things like working from home and online shopping and distributed workforces all just layered into the momentum the industry had," he said.

And investors have taken note.

"Over the past 90 days, we're seeing a massive shift in capital toward this industry by big investment funds," said Andy Cvengros, senior vice president and a member of the technology solutions practice at JLL, a real estate services and investing company.

Goldman Sachs announced in October an investment of up to $500 million in data-center infrastructure, and the private equity firms Blackstone and KKR have recently announced data center investments.

Real estate investment trusts focused on data centers delivered returns of 19% in the first half of 2020 — one of only two REIT sectors that showed growth, according to a recent report by JLL. (The other sector, industrials, yielded a modest 2% return.) By comparison, returns for hotel and resort REITs plunged 49%, those for retail fell 37% and office space dropped 25%.

Data centers have emerged as a critical part of the digital infrastructure that connects people and businesses to one another and the rest of the world, said Jon Lin, president for the Americas region at Equinix, one of the largest global data center companies.

"We're the foundation, in a lot of ways, for that digital infrastructure," he said.

That infrastructure is no longer just the purview of technology companies. The Sept. 11, 2001, terrorist attacks and Hurricane Sandy in 2012 prompted many companies across a variety of sectors in New York, like finance and media, to rethink their information technology as a hedge against future disasters or damage. Now, pandemic-induced office closures and remote work arrangements are spurring corporations to reevaluate where and how they house their central nervous systems.

"A lot of companies had been moving into cloud-based services before, but the lockdown forced them to move to cloud-based a lot faster," said Keith Snyder, an equity analyst at CFRA Research, an investment research firm.

Demand for space in data centers is also being fueled by the growing number of businesses that use cloud services to manage their operations without having to buy, maintain and update hardware and software. Many providers of these services want to have electronic outposts near their clients' servers.

"You think about data as an intangible asset, but data has to be stored somewhere," said Milena Petrova, an associate professor at Syracuse University who teaches real estate and corporate finance.

The more data a company is going to analyze, the more it is going to need to invest in servers and storage space, she said. Larger companies might be able to afford to buy that kind of space, but for many others, it's cheaper to lease space in a data center that houses multiple companies under one roof.

And storage providers are trying to make leasing as easy as possible by offering flexible size and payment options.

"You can go to the cloud and swipe your credit card and have data center space on demand," said Cvengros of JLL.

The coming rollout of 5G cellular networks is expected to stimulate the need for more computing and data storage on an enormous scale as well.

Silicon Valley might have the reputation as the shiny place where the future happens, but real estate professionals say data centers are being built all around the country. Most are on the outskirts of major metro areas including Atlanta, Chicago, Dallas-Fort Worth, New York and Phoenix.

A key criterion in site selection is proximity to the clusters of undersea cables that send and receive data from all over the world. In the United States, the cloud's Grand Central Terminal is northern Virginia.

"The Ashburn area outside D.C. is the largest data center market in the world," said Lin of Equinix. "It's really the hub of the digital economy in a lot of ways."

Other considerations include the costs of land and local taxes. Building a facility can create as many as 1,000 temporary jobs. Completed data centers do not require large labor forces, but the jobs are generally high paying, so cities and states compete fiercely for these developments by offering tax incentives.

Data centers typically are new construction, given the challenges with retrofitting a building to meet requirements, such as raising the floor above the foundation and running powerful cooling systems to keep the hardware from overheating.

"Data centers are hungry in terms of power consumption," Snyder said. "Reliable power delivery is probably one of the most important factors in choosing a location."

All the complexities make choosing a site to build a data center more complicated.