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Experts: Fundamental Shift in Economy Propels Data Centers to Forefront of CRE Industry

CBRE, Microsoft, Silicon Valley, Seattle, Southern California, Black Stone, Equinix, Harrison Street, DataBank
Courtesy of Hunter Harritt.

By Meghan Hall

2020 produced both winners and losers in the commercial real estate industry, and with the sector flipped on its head, several previously “niche” asset classes have emerged as major contenders. One of those growing asset classes includes data centers, considered a rapidly growing real estate sector even pre-pandemic. However, as consumer livelihoods—and lifestyles—have become more tech centric, demand for data center real estate has “exploded,” according to recent data released by brokerage firm CBRE.

“High level, 2020 was an acceleration of a fundamental shift in our economy that we’ve been seeing over the last 10 to 20 years—the digitization of our economy,” explained CBRE Senior Vice President Jerry Inguagiato. “…Data centers are at the forefront of supporting that shift…All of the infrastructure that supports the cloud and the internet, that is all supported in the physical land and buildings and infrastructure…”

Inguagiato cites a pivotal moment in 2020, during which Microsoft executives stated during an earnings call in May of 2020—at the height of the pandemic—that it saw multiple years of growth in roughly two months. The continued emphasis placed on digital infrastructure, as well as new technological innovations, has been the main driver of the sector.

During the second half of 2020, total inventory in primary markets—Northern Virginia, Toronto, Dallas-Fort Worth, Silicon Valley and Atlanta—grew by 159.2 megawatts (MW), or 5.9 percent. While demand also fell by 11 percent year-over-year as companies initially navigated the shock of the pandemic, CBRE states that absorption in 2020 was still high when compared to historical data.

Of the primary markets listed, Silicon Valley remains perhaps the tightest data center market in the country. Silicon Valley currently has 292.1 MW of inventory and a vacancy rate of 2.3 percent—by far the lowest in not just North America, but worldwide.  The market saw 26.6 MW of absorption in 2020, down 25 percent from 2019. However, CBRE mostly attributes this to the market’s extremely limited supply.

“I think we would have seen even more leasing momentum last year if there had been enough product in the market. We closed the year sub-three percent vacancy—it’s crazy,” said Jennie Karnes, vice president with CBRE’s Data Center Solutions in San Francisco.

Karnes continued, adding, “While Silicon Valley’s vacancy rate is low, relief is in sight. The region has a hearty development pipeline of more than 300 MW poised to deliver over the next five years, in addition to the 50.1 MW currently under construction. This pipeline combined with demand from cloud service providers and neighboring fast-growth tech companies positions Silicon Valley to persist as one of the largest and most active data center markets in the world.”

Of the 50.1 MW under construction in Silicon Valley, 74 percent has already been pre-leased, according to CBRE.

CBRE predicts that Silicon Valley will maintain its status as one of the top data center markets long-term, not just due to development and high-levels of demand, but because of land constraints within the Bay Area. Inguagiato notes that due to the region’s housing crisis, many municipalities are converting industrial-zoned properties—those that data centers typically occupy—into different uses. In recent years, San Jose has converted more than 16 million square feet of space from industrial to other uses; Santa Clara has also changed zoning on more than 100 acres of property.

“We have a very finite amount of land that can be developed with proximity to that core marketplace. That’s a challenge; it will continue to be a challenge,” said Inguagiato. “Generally, data centers exist in industrial markets. You don’t find them in Class A office, and industrial markets are running incredibly lean and tight. They have been for a better part of a decade.”

Secondary markets, which include geographies such as Seattle and Southern California, saw a 9.6 MW decrease during the second half of 2020. However, these markets are poised for growth in the coming year as demand for 5G, Edge and IoT technologies increases. Seattle led secondary markets in absorption during 2020, with 6.9 MW. Southern California also saw positive leasing momentum, with 5.5MW of net absorption.  In these markets, colocation providers are expected to drive demand, and highly connected facilities will see more stabilized pricing when compared to their older, less updated counterparts.

As a result of their relative stability during the pandemic, data centers were one of the highest performing public real estate sectors during 2020, with investment up 21 percent overall. Major investors such as Blackstone, Harrison Street, Equinix and DataBank made big investments across North America during 2020, transforming the sector into an institutionalized asset class. Looking ahead, CBRE only expects this trend to continue.

“With data usage growing at an explosive rate, we expect data center demand to increase across both primary and secondary markets in 2021,” said Pat Lynch, senior managing director, Data Center Solutions, CBRE. “To capitalize on this growth, data center providers will look to deliver network and interconnection offerings to better connect business-critical applications, as well as to meet anticipated demand for evolving technologies like 5G, Edge computing and the internet of things—all of which will further fuel the data center real estate market.”