The COVID-19 pandemic has led to mass adoption of technologies, and the resulting increase in global internet traffic and data creation is without precedent, driving growth in demand for data centers.
Data centers are best described as buildings designed specifically to house computer systems and network equipment. They differ from standard industrial buildings because of the more-complex technical specifications for the physical building and the fit-out, which comprises large amounts of electrical and mechanical hardware. Tenants usually sign long leases because of the high initial costs incurred. This provides resilient income streams.
To date, supply growth has been focused in major cities, where economic and demographic drivers underpin strong demand. Key technical factors for the sector include the availability of cloud operations, power and fiber network cable connectivity, and land cost and government policies.
Data centers are still viewed as a niche real estate asset class, but transparency and liquidity are improving as the sector grows. Including corporate acquisitions, total transaction activity averaged US$25 billion per annum from 2017 to 2019, showing notable growth in capital flows.
Investors can invest via three main structures: a powered shell and core structure; with or without fit-out; or as fully owned operators. These are distinguished by several key investment options, and leasing profiles vary.
Globally, unlevered returns for powered shell and core data centers are estimated at 11%per annum on average. The sector is expected to continue offering attractive returns in the coming years, with potential for further yield compression. Major investment risks include technological obsolescence and depreciation, a limited pool of operator-tenants and government policies.
The United States is the largest data center market in the world. Total capacity has grown 10% per annum over the past five years as the market continues to scale up, though the gradual vacancy uptrend has weighed on rents.
In Europe, data center demand has reached record levels, led by strong absorption from cloud providers. Over the past five years, total returns have been estimated at 16% per annum, outperforming the global average largely because of a rental recovery.
In Asia Pacific, capital flow toward data center development remains strong. Despite an expected significant increase in supply, occupancy rates are likely to remain high, supported by robust demand from hyperscale cloud providers.