Data centres are the darlings of the commercial real estate investment world right now.
That’s certainly not news to David Cervantes, CBRE’s Montreal-based Senior Vice President who runs the company’s data centre business along with his colleague Vice President Scott Harper in Toronto.
Both men have spent the last eight years building the data centres business into one of the company’s top revenue generators. Harper notes that the inventory of modern data centres in Canada is more than doubling every year.
Sure, industrial is doing well at the moment, as e-commerce surges amid the pandemic. But the smart money is focused intently on data centres. “Since COVID, many articles have been written on the stability and protection that the industrial market offers,” says Cervantes. “But data centres are actually outpacing the industrial sector in most metrics. REIT performance has been very strong in this space, and asset class allocations are scaling upwards among the large investor groups.”
Harper estimates that while the office, industrial and retail REITs saw between 30 to 40% of their value carved off when COVID hit, investment in data centres was up 7.0% in the second quarter of 2020. “As COVID drove traditionally focused REIT values down,” he says, “capital went looking for more fertile fields.”
The COVID-triggered rise in e-commerce traffic created a small increase in retail data. But the more direct driving force for the data centre sector, according to Cervantes, is actually consumer demand for media. “The recent and rampant takedown of data centre space by TikTok, by example, has been the talk of our industry” he says. “It’s all about eyeballs and usage rates—it’s the next apps and platforms that deliver media to people and phones in our pockets that drive data centre demand in our market.”
Data centres are counter-cyclical by nature, so, as was the case during the Global Financial Crisis of 2008, there has been a flight to data centres by the major institutional investors in the wake of COVID. “The secret is out and institutions of all types are investing in this space and projects are becoming very large,” says Cervantes. “These days even a small data centre costs more than $100 million, so cost of capital is the game, and this space is a safe place for it to camp.”
CBRE Caledon Capital Management Inc. just acquired a minority stake in a new platform with 12 Vantage Data Centers. “When we look at the digital infrastructure sector, what we see is revenue that’s based on data growth,” CBRE Caledon’s Stephen Dowd said in announcing the deal. “Data growth is uncorrelated with economic cycles, which has been an especially strong point this year.”
Earlier in the year, Compass Datacenters purchased land for its first Toronto campus, in Etobicoke, with the initial building—a $100.0 million investment—expected to be completed in Q3 of this year. “Our customers see Toronto as an emerging, important hyper-scale market," said AJ Byers, President, International of Compass Datacenters. "Toronto is the latest step in our effort to expand in key markets across North America," added Compass’ CEO and industry visionary Chris Crosby.
Harper notes that these firms could be motivated in part by the highly publicized plans by Canada’s major telcos, Rogers and Bell, to expand to 5G networks, which will cost upwards of $7.0 billion. “Then we’ll see an expansion of the data centre footprint for that,” he says. “So that’s going to be a considerable factor.”
It’s not only domestic investors excited about Canadian data centres. Along with other cheaper-power markets such as Sweden and even Iceland, Canada has become a popular destination for global investors as they pursue cloud providers like Microsoft, IBM, Amazon, Google and Oracle. In the process of exploring secondary markets, like Canada, they are chasing higher yields than may be found in America.
For his part, Harper is in the midst of a $45-million sale of an existing data centre, to international interests, and he points to a number of other capital market transactions in Toronto in recent months, including an increasingly scarce brownfield conversion (the bulk of new data centre projects are new greenfield developments, to meet global standards), as well as several mergers and acquisitions.
“Pay what they have to”
For a decade now, Quebec has become the destination of choice for large or “hyper-scale” data centre deployments, owing to the province’s inexpensive and renewable power. But data centre developers, providers and investors have now grown “agnostic to power costs,” says Harper. Large cloud operators, the so-called hyper-scalers, are growing at a dizzying pace in order to meet cloud demands, and that means they need to be right where their clients are—Toronto. “They have no choice. That’s the cost of doing business.”
Data centres are the most expensive and complicated of all asset classes to build, Harper explains, because they require twice the infrastructure — all the electrical lines and transformers must be doubled up, for back up. “So say a trophy real estate asset is $450 per square foot to build. Well, a data centre is the building plus all the infrastructure, so it’s closer to $1,200 per square foot.”
Large pension funds and well-capitalized investor groups fit hand-and-glove with data centres as an asset class; They’re able to disperse tremendous amounts of capital in a single transaction, backed by some of the best covenants on the planet, like Microsoft, IBM, Amazon, Google and Oracle.
These wholesale data centre groups can be considered the “Walmarts” of cloud services, a reflection of their dominance, as they represent as much as 75% of current global demand with the other 25% being comprised of “everybody else”, namely thousands of enterprises and firms such as high-frequency traders, retailers, film and game designers, to name only a few.
“There’s very little risk from investing in data centres,” says Harper. “Instead of doing nine transactions to get to $500 million you can do one real estate deal. It becomes an efficient deployment of capital and still offers healthy returns. That’s why the largest players in the capitalization of real estate around the world, are all looking at these deals.”
Data centre deals are typically for 10 or 15 years, as well, which, coupled with AAA covenants, means that “once they’re in there they’re not likely to leave,” says Cervantes. “The asset is very sticky.”
Not surprisingly, new players are seeking to enter the data centre space but it’s not simple, cautions Harper. “There is more capital chasing data centres today than five months ago, but it’s challenging to get into the business. If you’ve never operated a data centre, then a huge enterprise group is not going to trust you… So the barriers to entry in the data centres world are massive.”
CBRE works closely with the developers who build data centres for the large global end users, and Cervantes knows quite well that these trillion-dollar firms have limited time and patience for smaller-scale data centre operators. “The big players are looking for a safe and consistent partner when they expand within new markets such as Canada.”