Data Center Panel Discussion Notes

Introduction - Committee Meeting Introduction

Pat Sartre introduces the service team assembled for the panel discussion, extending a welcome to both the distinguished panel members and the audience. It is noted that a reception will follow the panel discussion, providing an opportunity for networking and further discussion.

Purpose of the Meeting

The discussion is specifically centered on data centers, a topic of critical relevance given the rapid advancements in AI initiatives and significant developments in financing structures within the market. The panel includes a diverse group of representatives, each offering unique perspectives from different facets of the data center ecosystem: tenants (the end-users of data center services), owners/operators (those who build and manage the facilities), financiers (lenders and capital providers), rating agencies (evaluating credit risk), and investors (seeking returns from data center assets). Erin Stafford, who serves as the head of the North American Commercial Real Estate Team at Morningstar DBRS, facilitates this comprehensive discussion.

Panel Introductions

• Nilesh Patel (Blue Owl):

  • Role: Responsible for investments in SASB (Security Asset-Backed Securitization) CMBS (Commercial Mortgage-Backed Securities) and various loans, with a particular focus on data center CMBS. This indicates expertise in securitized debt instruments backed by commercial real estate, including data centers.

• Steven Douglas (QTS):

  • EVP of Finance at QTS, where he oversees capital markets activities and asset management. His role specifically focuses on digital infrastructure, highlighting his understanding of the financial and operational aspects of large-scale data center facilities.

• Michael Goodmar (Morningstar DBRS):

  • Leads a specialized team dedicated to rating various data center assets across different financing platforms, including ABS (Asset-Backed Securities), CMBS, and private credit. This involves assessing the creditworthiness and financial stability of data center projects and operators.

• BK Lee (Austin, New York):

  • A Partner with a broad asset securitization practice that specifically includes transactions related to data centers. This suggests expertise in structuring and executing complex financial deals involving data center assets.

• Chris Bisotil (Goldman Sachs):

  • Primarily focuses on CMBS securitization across a wide range of property types, including the increasingly important data center sector. His role involves packaging commercial mortgages into salable securities for investors.

Demand Changes Over the Past Five Years

• Demand Overview (Steven):

  • There has been a significant shift in the market from companies owning their own data center infrastructures to increasingly leasing space within professionally managed data centers. This move is driven by the need for scalability, efficiency, and reduced capital expenditure.

  • The exponential growth of hyperscalers (large cloud service providers like Amazon, Google, Microsoft) has dramatically increased demand for massive data center capacity.

  • Infrastructure requirements have scaled up considerably: five years ago, a substantial data center deal might involve an IT load of $30$ megawatts ($MW$), whereas today, deals frequently reach $300$ megawatts ($MW$), representing a tenfold increase in power demand.

  • This massive increase in scale presents significant challenges, including securing sufficient specialized equipment (servers, cooling systems), acquiring suitable land often with specific zoning and infrastructure capabilities, and, most critically, ensuring access to immense and reliable power supplies.

  • The development process has fundamentally changed in response to this demand: equipment purchases are now often prioritized and committed before land acquisition is finalized, to secure necessary components amidst supply chain constraints. This shift increases financial risk.

  • Predevelopment costs have surged, now accounting for $15-25$ of the total project cost, compared to just $5-10$ before a lease is even signed. This higher upfront investment is due to extensive site studies, engineering designs, and power grid negotiations required for these larger facilities.

Sustainability and Resource Conservation

• Current hyperscaler clients are highly focused on aggressive sustainability initiatives, driven by corporate responsibility goals and regulatory pressures.

• Projects are increasingly designed to guarantee a Water Usage Effectiveness (WUE) at zero, meaning that the data center's operations do not consume additional municipal or external water resources for cooling, often achieved through advanced closed-loop systems or air-cooling technologies.

• There are ambitious plans for building approximately two gigawatts ($GW$) of new infrastructure with the objective of achieving zero additional water resource utilization, demonstrating a strong commitment to environmental conservation in critical areas with water scarcity.

Development Timeline Insights

• Development Phases (BK):

  • The total timeline for developing a hyperscale data center typically ranges from three to six years, a considerable investment of time and resources.

  • Site selection alone can take six to twelve months, involving detailed analysis of power availability, fiber connectivity, potential for natural disasters, and local government incentives.

  • The permitting process is crucial and often lengthy, involving securing various local, state, and sometimes federal approvals, which can include negotiations for tax incentives, energy credits, and environmental impact assessments.

  • The construction phase follows, typically lasting between twelve to thirty-six months, encompassing the build-out of the physical facility, power infrastructure, and cooling systems.

  • A final commissioning/testing phase, lasting two to four months, is essential to ensure all systems are fully operational, efficient, and meet stringent performance and reliability standards before tenant occupation.

  • The U.S. generally offers better Return on Investment ($ROI$) potential compared to Europe, largely due to often more streamlined and predictable development processes, greater land availability, and more competitive power markets.

Financing Data Center Developments

• Financing Innovations (Chris):

  • There is an increased emphasis on comprehensively understanding the entire project lifecycle, specifically the timeline for development, the overall budget, and the ultimate exit strategy for the investment, critical for assessing risk and return.

  • The costs associated with building the necessary power infrastructure for a data center are substantial, estimated at approximately $13$ million per megawatt ($MW$) of capacity. This high cost underscores the capital-intensive nature of data center development.

  • The market has seen a significant growth in various specialized financing mechanisms to support data center projects:

  • Introduction of PACE (Property Assessed Clean Energy) financing, which allows property owners to finance energy efficiency, renewable energy, and water conservation improvements through a voluntary assessment on their property tax bill, suitable for sustainable data center upgrades.

  • ABS (Asset-Backed Securities) and CMBS (Commercial Mortgage-Backed Securities) are experiencing record high issuances, indicating robust investor appetite for securitized debt backed by diversified income streams from data center leases or property assets.

  • Unique construction loans are now being specifically securitized as bespoke transactions, allowing developers to finance the capital-intensive construction phase with tailored debt products that can be sold to investors.

Tenants' Perspective on Leasing

• Increased tenant demand, particularly from hyperscalers, means data center operators can often dictate more favorable terms, including potentially shorter lease agreements or more flexible structures.

• Hyperscaler Trends (BK):

  • Data center owners/operators generally welcome tenant turnover in the hyperscaler segment because it provides opportunities to reset market rates and capture higher revenues in a rapidly appreciating market.

  • Hyperscalers prioritize flexibility above all else, driving a trend towards shorter lease agreements, often incorporating predefined exit conditions or expansion options to adapt to their dynamic infrastructure needs.

• Service Level Agreements (SLA):

  • Tenants, especially large hyperscalers, frequently negotiate and include stringent Service Level Agreements (SLAs) with harsh termination options. These provisions are crucial for tenants to retain maximum flexibility, allowing them to exit agreements or impose significant penalties if performance metrics (e.g., uptime, power delivery, cooling efficiency) are not met, reflecting their critical reliance on uninterrupted and high-performance infrastructure.

Risk Management and Investor Considerations

• Investors frequently express concern regarding the potential for lease breaks, particularly in deals involving large hyperscaler tenants. The risk of a major tenant exercising early termination clauses can significantly impact cash flow and asset valuation.

• However, despite these concerns, overall confidence in the data center sector remains remarkably high. This confidence is primarily driven by the consistent and escalating demand from top-tier, creditworthy tenants (hyperscalers), who represent a robust and growing customer base.

• Discussion within the panel emphasized the critical importance of establishing and maintaining strategic, long-term relationships with utility providers. Reliable access to massive power is the lifeblood of data centers, and strong utility partnerships are essential for securing future capacity, negotiating favorable rates, and ensuring grid stability.

• Another significant consideration revolves around energy sources:

  • The issue of power supply insecurity is a growing concern, with potential implications for data center operations and expansion. Reliance on stable grids and diversified energy sources becomes paramount.

  • There is a growing awareness among developers and investors of the long-term benefits associated with renewable energy sources. Investing in or sourcing renewable energy not only addresses environmental sustainability goals but can also mitigate future energy cost volatility and enhance corporate image.

Obsolescence Risks in Data Centers

• Power as the Critical Commodity (Steven):

  • The primary focus in data center design and investment has fundamentally shifted away from just physical space (square footage) to the underlying power and cooling infrastructure. The ability to deliver massive amounts of reliable power and efficiently dissipate heat is now the most critical determinant of a data center's value and longevity.

  • To prevent rapid obsolescence, scale and flexibility are paramount. Data centers must be designed to accommodate future generations of compute hardware (which will likely be more power-intensive) and allow for easy upgrades or reconfigurations of power delivery and cooling systems without significant downtime.

• Emerging Markets:

  • There has been a notable trend of data center development shifting towards new markets, such as New Albany, Ohio. These moves are primarily driven by the availability of abundant and affordable power, as well as favorable land characteristics and local incentives, which are increasingly hard to find in established, densely populated data center hubs.

Conclusion and Wrap-Up

• The panelists collectively expressed strong confidence in the continued growth trajectory of the data center industry, despite acknowledging the various operational, financial, and environmental challenges it faces.

• The session aimed to provide attendees with key insights and final thoughts on effective strategies to