COMMENT As Covid-19 moved the world online, the amount of data generated surged. Global internet traffic rocketed, driven by growth in video streaming, video conferencing, online gaming and social networking.
There has been a huge swell in demand for digital services over the past decade. In 2020, 59% of the global population was connected, more than double the percentage 10 years earlier. Over the same time, global internet traffic has grown 12-fold, and the amount of data collected in industry is also increasing at an unprecedented rate, triggered by the rise of the internet of things, artificial intelligence, augmented reality and blockchain.
To accommodate this explosive rise in demand for storage capacity, the number of data centres is rapidly expanding around the globe. The global data centre market size is expected to reach $251bn (£181bn) by 2026, growing at average annual rate of 4.5% between 2020 and 2026.
Cloud infrastructure has played an important role in enabling businesses and governments to apply solutions quickly in responding to the crisis. According to Snow Software, which surveyed 250 IT leaders globally last June, 82% of respondents said they had ramped up their use of the cloud to enable remote working and 45% plan to accelerate the pace of their cloud migration.
With the unprecedented cloud shift likely to become pivotal for many companies and institutions, demand for cloud data centre facilities will continue to grow for the foreseeable future and will bring in its wake growing requirements for co-location facilities.
Hunt for scale
The surge in demand for cloud and co-location services has triggered a hunt for scale and global footprint within the industry, with competition fierce between giant IT companies and smaller market players.
Since 2015, consolidation among service providers has been increasing. In 2017, Digital Realty acquired DuPont Fabros for $7.6bn and 2020 set a new record thanks to Digital Realty’s acquisition of Dutch data centre company Interxion for $8.4bn, the largest-ever data centre M&A transaction.
While Covid-19 has brought data centres in the spotlight, investors’ interest for the sector has been growing over the past five years. The fundamentals of the sectors are strong with flourishing demand set to grow dramatically in the next five years.
As data centre migration is a highly complex process, tenants usually occupy the premise for a long period, ranging from 10 to 30 years. Hence, the sector offers a long-term income stream and security.
Nevertheless, high barriers to enter the market are restraining private capital’s exposure in the sector. Firstly, particularly high infrastructure costs mean that data centres are expensive to build. Secondly, for non-specialists, they are also complex to manage and require scale to achieve profitability. Thirdly, due to the speed of technological development, obsolescence is another concern involving expensive maintenance and upgrading costs.
Yield compression
As a result, most of the existing data centre stock is owner-occupied, predominantly by a few specialised public REITs, which have been dominating the market. This includes notably the US-based Digital Realty and Equinix REITs and the Asian Keppel DC REIT. The strong polarisation of market players has had a catalyst impact on the market liquidity and transparency, dampening the opening of the market to private capital.
Yet over the past three years, non-specialist private institutions have slowly entered the data centre investment market, including general REITs, investment managers, institutional investors, sovereign wealth funds and infrastructure funds. To circumvent the lack of transparency and the high level of specialism required in the market, partnerships, joint ventures and entity acquisitions will be increasingly used by private investors to enter the market.
Overall yields are attractive compared to other asset types, with large differences across the globe, reflecting the liquidity premium. In the US, the most liquid market, prime yields range from 4% to 12%, a wide range which very much depends on size, tenure and various locations across the country. In Japan, prime data centre yields range between 4% and 5%, in Western Europe between 5% and 7%, in Singapore between 6% and 7%, in Malaysia between 7% and 7.5% and in China between 8% and 12%.
As the market is rapidly maturing and in the face of pent-up demand, we expect strong yield compression in the next one to two years. This is most particularly true in China, where yields are still relatively high and where requirements for data storage are expected to be one of the fastest growing over the next five years.
Lydia Brissy is director of European research at Savills
