Data Center Development Moves Well Beyond Northern Virginia
That region's still king of the asset class, but investors' rapacious need for energy is driving investors farther afield
The tech industry is sounding more and more like classic rock band Bad Company, but instead of “can’t get enough of your love,” they’re asking for data centers. Lots of ’em, and in more newer markets than before
Demand for data centers has given rise to a global building spree in the last 10 years, and new breakthroughs in technology are only putting more pressure on an already behind construction pipeline.
With the recent emergence of artificial intelligence, at least in a way that has become accessible to the public at large, developers are finding themselves at odds with the availability of land, the power grid, and energy sources as they struggle to create space for the storage of data.
And there are challengers in the game as well.
The same kinds of properties targeted by data center developers also fit the description of what industrial builders need to meet the significant demands for warehouse space in a world that can’t stop ordering goods online.
Like industrial space, data centers are seeing extremely low vacancy rates, with about 3.3 percent of existing space available across North America as of the first half of 2023. The vacancy rate is just 0.94 percent in Northern Virginia, long the biggest data center market in the country — if not the world — according to CBRE.
It doesn’t even take long for tenants to find where they’ll be able to store data, either, with 1,673.1 megawatts pre-leased during the first half of the year. That’s 73.1 percent of the 2,287.6 megawatts that were under construction during that period.
Pat Lynch, CBRE (CBRE)’s executive managing director of data center solutions, and Gordon Dolven, the brokerage’s director of data center research, told Commercial Observer that the demand for data center space lags so far behind in part because projections for demand in the past haven’t aged well.
“I’ve been in the space for 20-some years, started in the telecom world, and throughout that time we have underestimated the demand,” Lynch said in an interview. “It’s not like office or retail where you have multiple cycles that you go back to. The industry has changed so much in terms of what we’re building, the size. Ten years ago, a 10-megawatt site was large. Today, 10 megawatts would maybe not even be big enough to start with.”
Nationally, rents continue to rise on available space as well, according to Dolven, with 7.2 percent increase in rent in the first half, compared to the second half of 2022, which is considered a conservative reflection of the market for the entire year.
“Pricing should be up double digits, and I’m thinking somewhere in the mid-teens year-over-year, which is incredibly impressive because in 2021 and 2022 we also saw double digits in terms of price increases,” Dolven said. “The pendulum has swung in favor of the operator, as opposed to the occupier, because of that lack of responsiveness of supply being able to come onto the market in an expedited fashion.”
Texas is one market where data center availability is growing the fastest, specifically in and around Dallas, Austin, Houston and San Antonio. Central Washington state has been another rapidly growing market for data centers. Omaha, Neb., and Reno, Nev., and the Atlanta region are other notable newer markets.
What’s more, Phoenix and the Pacific Northwest both outpaced Northern Virginia in their absorption of space in the first half of 2023, with 194.5 megawatts and 185.9 megawatts for each market, respectively, according to JLL (JLL). Northern Virginia saw only 184 megawatts of leasing in the same period.
But where industrial and data center developers clash the most is in areas with proximity to a utility substation.
“We have a client that we worked for in the Pacific Northwest that had a site that was right next to a substation, had readily available power, somewhere around 30 megawatts, and that turned into a bidding war and the site transacted for three times what the original listing price was,” Lynch said.
Megawatts aren’t enough for some of CBRE’s clients, however. Instead, gigawatt campuses are in the works. In that case, the developers are venturing farther from cities, into more rural areas, and partnering with utility suppliers.
“You’re not typically going into a market and finding a gigawatt of idle power,” Lynch added.
Hyperscalers, financial firms and health care companies are the primary tenants taking data center space, according to JLL. An August report from the brokerage said that the majority of what will be delivered in the third and fourth quarters of 2023 has already been pre-leased or was developed for exclusive use.
If the federal government is interested in alleviating some of the constraint on the power supply side of things, Dolven believes there needs to be something like the Federal-Aid Highway Act of 1958 to get energy where it needs to be without having to navigate a fragmented grid. Otherwise, development will continue to be slowed by the capital needed to build high-voltage transmission lines.
There are smaller-scale, public-private efforts on the local level to move electricity farther, such as the SunZia Wind project that harvests electricity in New Mexico and moves it through Arizona and California. Another is the TransWest Express Transmission Project that starts in Wyoming and sends electricity, again, to California.
Venture capital and private equity have poured $32 billion in investment funds into artificial intelligence and machine learning, which in the first quarter of 2023 put demand for data centers on steroids.
AI doesn’t change just the amount of space needed for data centers. It also shifts the amount of power densities needed, pushing the technological boundaries of not only supplying energy but also cooling the equipment stored inside them.
JLL’s Curt Holcomb told CO in August that the number of colocation providers — those who specialize in managing data centers — is small. There are only 12 to 15 major names doing 80 percent of the work in all the major markets.
Again, California appears to be an anomaly, with data centers in Silicon Valley and Los Angeles, but these are owned and occupied by tech companies that need to have that storage space, according to Holcomb.
Holcomb, who is based in Texas, said Dallas is seeing a lot of demand as a hub for Fortune 500 company headquarters and other major firms with offices in the area. Power is abundant and relatively cheap. Companies don’t even need to be in Texas to lease data center space, with Dallas having one of the busiest airports offering direct flights from anywhere in the country.
The conveniences and savings of a Dallas data center go a long way, too.
A 10-megawatt facility could cost $100 million to build and span 100,000 feet. But that kind of facility is going to be packed with IT equipment ranging anywhere from $300 million to $500 million. Then there’s the hard cost of the lease. Asking rents for data center space increased 20 to 30 percent across North America in the first quarter alone with a 50 percent increase predicted by the end of 2023.
Sales tax abatements in states like Arizona can also knock an additional 6 percent off the purchase price of the hardware itself, Holcomb said, adding that the equipment generally has to be replaced every four years.
“It could be a billion dollars worth of gear that goes in the data center on top of the infrastructure,” Holcomb said.
Mark Hallum can be reached at email@example.com.