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Companies and governments rely on information and software systems that are increasingly complex and integrated. The digital infrastructure required to support our economies and lives has piqued the interest of real estate investors.
Data centres are a notable example of this. Globally, more than 50 real estate funds are currently capital raising and actively seeking exposure to DCs, with a combined target size of over US$50bn. Around 40% of this total is being raised specifically to invest in data centres.
Real estate investment markets have had a torrid time since the covid pandemic and Investors, managers and developers are now diversifying into digital infrastructure in general and data centres in particular. However, excitement and enthusiasm should not obscure the myriad challenges.
The data centre tenant pool is shallower than for an office block or a shopping centre. The hyperscalers, Google, Amazon and Microsoft, comprise a significant proportion of the occupier market. Their specifications are exacting and their terms stringent. Your data centre will not be their first rodeo.
The leases (often called customer contracts) will also be unfamiliar to those approaching this market from a real estate background. Investors will need to be open to departures from triple net lease terms. It is common for a data centre landlord to bear the cost of providing certain services to occupiers; from power and utilities to security and facilities management.
This potential exposure to inflation and other market forces involves more complex modelling than simply working out a rental yield. In other ways, however, the investment profile is coming more in line with a real estate business. For example, lease lengths have been creeping up and UK average capacity uptake has increased eightfold in the last five years, from 5MW in 2019 to 40MW in 2024.
The utilitarian appearance of data centres belies the technical and operational expertise required to build and run them. Delays during development, or service interruptions during operations, can have huge financial consequences. Upfront capital investment is substantial. Whilst inflation in many key data centre markets has settled in the last 12 months, construction costs remain high.
A shortage of skilled labour is a further cost factor, and one that cannot be solved overnight.
Joint ventures and co-investments facilitate the marriage of expertise and capital, leading to a bonanza of investment activity from private equity and institutional funds. These structures also allow participation by a larger number of players, including those unwilling to foot the capital required by ballooning transaction ticket sizes.
As the data centre investment market matures, a trend has emerged of segregating operational assets from those under development. This allows investors and funders to take exposure to different stages of the data centre life cycle: from a high-risk, high-reward construction proposition appealing to investors from a real estate development background; to a stabilised, yield-producing product sought by a pension or infrastructure fund.
Careful consideration of investment, debt and exit strategies from the outset will pay dividends, often quite literally, in the long run. Ensuring that title to land, construction contracts, operational agreements and even employees sit in suitable corporate vehicles is crucial. Likewise, it will be prudent to keep individual data centres physically separable, even if they are developed on the same campus. Shared infrastructure and other interdependences can compromise future flexibility to hold assets in different investment pools or debt security ringfences.
Servers, network equipment and other apparatus consume power voraciously and competition for grid connections and electricity supply is fierce. Delays in securing power threaten data centre build programmes globally. The vagaries of renewable electricity production pose a challenge for data centres’ 24/7 power requirements. The answer may be innovation: Google has commissioned small modular nuclear reactors (SMRs) and Amazon has a acquired a stake in a company that builds SMRs. Perhaps nuclear is, once again, the future.
These consumption demands have gained the attention of governments and regulators, bringing both challenges and opportunities. Data centres’ energy usage makes them a target for climate legislation. Germany’s Energy Efficiency Act introduced specific requirements on energy efficiency for data centres. The UK government now classes data centres as ‘Critical National Infrastructure’ alongside traditional utilities and emergency services, ensuring government support to anticipate and recover from critical incidents.
The likely trade-off is stricter regulatory oversight and compliance with security measures. Ireland’s Commission for Regulation of Utilities (CRU) is trying to balance Ireland’s burgeoning data centre market with the nation’s climate and sustainability targets. A pause on new data centre developments around Dublin introduced in 2021 may be a precursor to the CRU report due this autumn setting out Ireland’s future energy interconnection policy. Data centres will increasingly be a focus for regulators in established markets, which may push development and operating costs higher still.
An increased need for data centre capacity is a function of relative regional economic development. Europe (principally Frankfurt, London, Amsterdam, Paris, and Dublin – so called FLAP+D) and North America have been the data centre leviathans to date. North America accounted for 62% of the global total data centre transaction values in 2023 and around 70% in the first half of 2024. Europe’s growth has been sharper, increasing its share from 6% in 2022, to 20% in 2023 and approaching 30% in the first half of 2024. As demand continues to outstrip supply, these markets will continue to grow.
However, the high cost of entry, increasing regulation and a squeeze on supply is also encouraging investors to broaden their horizons. This is coinciding with an increasing demand in emerging data centre markets. The Gulf is a case in point: Saudi Arabia’s ‘Vision 2030’ aims to diversify the Saudi economy beyond oil and has technological innovation at its core. Other Gulf states are pursuing similarly tech-forward economic strategies. The region’s digital infrastructure requires significant investment to facilitate these transformations. International players with resources and experience will be key, but so too will partners with an understanding of local market dynamics. Construction and energy costs will be lower. However, foreign investment regimes, state-controlled free zones and less familiar legal jurisdictions present their own challenges.
Our data centre dependence seems set to continue. In North America and Europe deal values are swelling and regulators are playing catch up. Investors and operators face a dual challenge: to innovate in existing markets and to seek out opportunities in new ones.
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