Cap Rate round up/critique

New York City’s Convene was the site for the well attended Cap Rate Data Center conference yesterday. The site was spectacular and I heard from many people that it was a HUGE step up from last year’s venue. Great place to host a 1000 person event in my opinion.

The event was a clear signal to me that the data center business is in flux, and the changes are being compressed as time marches forward and the buildings that house the technology that drives the information age are quickly approaching a crossroads. The conference is primarily for the investor and owner/operator crowd so the event this year (as in virtually every other data center event) spent a lot more time looking backwards over the past 5 years and future/forward looking statements were typically one offs right before the Q&A, yet the impending future is where the substantial risk is and with all of the finance people in the room, I expected more discussion of risk vs. how great the market and industry is while presenting a ton of data to the contrary.

The key takeaways for this attendee were:

  1. Data centers are largely seen as a commodity by brokers, but operators believe they are anything but
  2. Many data centers are 10-15 years old and are at or just overdue on a significant refresh of mechanical & electrical
  3. Modular is still seen as a niche play
  4. Pricing pressure is definitely in the market – too much supply in many markets forces prices down in every market
  5. Secondary and tertiary markets are where the action is and will be

My comments on the takeaways:

  1. The data centers are commoditized by brokers because they do not understand the technology inside them. They do not understand cloud, SSD vs disk, wavelengths, dark vs lit, systems architecture, or virtualization so they commoditize what they do know – buildings and price. I thought it was interesting when Jeff Moerdler from Mintz Levin stated that the negotiation of contracts was being driven more by the CTO than the Real Estate and Facilities groups because the terms were less about leases and more about SLA’s today because of the technology, not the real estate. Brokers need to step up their game or hire people who can talk tech.
  2. There was a fair amount of discussion about the topic of age of facility. It’s important because densities are increasing, the technology in data centers is changing more rapidly than ever, and if you have an older facility you are looking at millions per megawatt to upgrade what you have while you have customers in it and are trying to attract new ones. There is a lot of downside financial risk there both in having to perform the upgrades and stay current/relevant. As the technically savvy companies who were the brass rings of the large data center deals over the past 5 years begin to build their own because it makes sense for them to do that, there will be additional inventory opening up in markets where Google, Yahoo, Microsoft, and Facebook had large chunks of space. That space is hard to re lease with just a fresh coat of paint and a broom clean computer room. It will be cheaper to build new. It will also be cheaper to build without generator and UPS because you deploy in a footprint vs a facility. You wont stub your toe and your heel at the same time.
  3. Modular is still seen as a niche play by the community which is shocking given the history of Blade Room, IO, and even HP, Dell, AST, and others. It’s a niche play for those who don’t understand cloud or computing as a utility yet. In fact Mike Hagan from Schneider read an email from a colleague while he was chairing a panel asking where there was a building to pit containers in because they had demand. The niche went mainstream in front of the jheavy hitters and everyone blinked. Folks – it’s getting technical. Fewer leases, more SLA’s, cloud, peering exchanges, modular – all things that were passed over by the industry years ago are now driving it, or brokers will be seen as a niche.
  4. Pricing pressure accelerates when there is too much competition or something is perceived as a commodity. Data centers are expensive to build, slow to lease up, and there are a ton of them out there. With building new facilities accelerating they are building into a buyers market. I heard that you could do a deal of 250 Kw+ with 5 different providers in Dallas right now for $100/kw. That is as low as I have ever seen. It’s also below what it takes to build and hold these facilities so deals they do they will be underwater on anyway. In older facilities. In a competitive largely commoditized business.
  5. I completely agree with this statement and spent 2012 and 2013 building a business plan that was built around the same premise, and was using modular to keep costs low so that when pricing pressure did accelerate the model would still make industry average margins. The smaller markets mean more, smaller facilities vs a couple of big ones and it also means that you get a single customer to more markets with one logo which is good for them provided there is consistency of product.

So if you are an investor looking to invest in the data center space, you’ll need to cut through the noise and get to where to put your money. If you believe the presenters, big facilities in established markets are where you want to be. Yet if you look at the data of where the majority of growing companies that use data centers as a strategic part of their business want to be, and what is driving those decisions, it’s in newer facilities in more places to service their customers who are using mobile more and more, who need storage backed up in multiple places and don’t want to pay to keep data at the Pentagon when a locked box in a small facility no one knows about is less of a target and just as connected. Look at the data and don’t listen to the hype. Find the next Compass, find the next IO, and do a deal to get em going, and you’ll do more deals to launch them into orbit.

At the end of the day I am glad I took 2 years off from going to these conferences. I missed very little. Same people, same presentations, only the dates on the slides had changed. Just because someone is talking about it doesn’t mean it’s valuable or important.

See you in 2016.


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