Why the coronavirus pandemic will turbocharge investment in data centres
- The turn to digital infrastructure during the Covid-19 pandemic has boosted the existing boom in investor interest in data centres
- Given that data centres are capital-intensive and require significant technical expertise, investors could consider investing directly in the operating company itself
The latest data on investment activity paints a grim picture of Asia’s real estate market. Last Thursday, JLL announced that transaction volumes across the region plunged 32 per cent year on year in the first half of 2020, with the decline in deals accelerating sharply in the second quarter.
The fallout from the Covid-19 pandemic led to a staggering 68 per cent drop in transactions in Singapore last quarter, an even sharper fall than in Hong Kong, the hardest hit market in the region over the past several quarters.
JLL attributes the slump partly to the huge uncertainty surrounding the strength of the post-lockdown recovery. Yet, it also notes that “defensive and operation-critical assets” are attracting significant interest as investors target properties with stable cash flows.
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In a sign of the extent to which the warehouse-like facilities are popular among investors, United States data centre real estate investment trusts delivered total returns of nearly 20 per cent in the first half of this year, compared with negative returns for retail and office Reits of 37 and 24 per cent respectively.
In Asia, demand for data centres is surging, underpinned by a large and rapidly growing market of young and technologically savvy consumers. According to Cisco’s latest Global Cloud Index, Asia has been the fastest growing region for the location of “hyperscale” data centres, large facilities that cater to the needs of the world’s tech giants.
High data centre rents let three firms dominate US$883 million sector
Leading data centre companies have expanded aggressively across the region, initially focusing on established markets, such as Singapore and Tokyo, but increasingly targeting emerging markets, particularly in China and India.
Earlier this month, Digital Realty, one of the world’s top providers of data centres, announced the development of a new facility in Hong Kong, strengthening its network across the region. Investors are eager to deploy more capital in the sector, which offers significantly higher rental yields.
However, according to a report by CBRE published last week, while data centres have become the preferred alternative sector in Asia, investment is limited mainly because of a lack of institutional grade product.
The dearth of investible assets stems partly from the fact that the Asian market is at an earlier stage of development compared with America and Europe. CBRE notes that data centres accounted for just 1.5 per cent of industrial property transactions across the region between 2015 and 2019. Moreover, unlike traditional property assets, such as offices and shopping malls, data centres are capital intensive and require significant technical expertise.
Factors that have little bearing on conventional real estate are crucial determinants of the investment rationale for, and the valuations of, data centres. Investors must consider a range of regulatory and politically sensitive issues, such as access to the power supply, connection to fibre optic networks and proximity to internet exchange points.
China’s embrace of tech industries entices private funds to data centres
In a study published in January analysing 1,162 data centres in 38 of the world’s leading markets, Cushman & Wakefield ranked Singapore as the sixth most attractive market based on 12 weighted criteria. However, while the city state scored well in cloud availability and fibre connectivity, its development pipeline “hangs in the balance” due to government plans for a sharp reduction in carbon emissions, which contributed to a moratorium on the construction of new data centres.
The main challenge for investors is “the ability to secure the required infrastructure,” notes Dave Fanning, head of C&W’s Data Centre Advisory Group, adding that “capital is best deployed as a team.” Due to the highly technical nature of the asset class, the real estate cannot be easily separated from the operational aspects of running data centres.
Although there are different ways for investors to establish a presence in the sector, one of the most effective is to invest directly in the operating company itself, reducing barriers to entry and allowing investors to quickly gain exposure to the industry.
Still, this is easier said than done. Not only do investors’ and operators’ interests need to be properly aligned, many real estate firms are reluctant, or are not allowed, to buy into operating entities given their potential liabilities.
Other investors, however, notably private equity and sovereign wealth funds, have considerable experience investing in infrastructure, giving them an edge in the data centre market. In April, Singaporean state fund GIC formed a US$1 billion joint venture with Equinix, a leading data centre specialist, to develop and operate hyperscale facilities in Japan.
If investors’ mandates allow them to gain exposure to the operating company, that puts them at an advantage, notes Rohit Hemnani, head of JLL’s alternatives investment team in Asia, adding that investors are in an even stronger position “when their footprint extend[s] across different regions.”
These are huge challenges for most property investors. But given how Covid-19 is likely to turbocharge the growth of data centres, more capital is bound to be allocated to the sector. The darling of alternative real estate is set to draw more investors in the coming years.
Nicholas Spiro is a partner at Lauressa Advisory
