The data center industry stands as a backbone of today's digital economy, relentlessly evolving under the pressures of ever-increasing demands and significant technological advances. In this context, private events, such as a recent one hosted by JLL's data center solutions team, provide a unique platform for industry insiders to delve into the nuances of this critical sector.
Unlike larger industry gatherings, private settings allow for a more intimate and forthright dialogue amongst participants. Agendas are carefully curated to address the most pressing issues facing data centers today, similar topics to those at larger conferences, yet eschewing typical marketing jargon in favor of honest, in-depth explorations of each topic.
JLL’s event aptly captured the essence of the current landscape across data center markets. It reflected the dual reality of rapid growth and significant limitations — be they technological, regulatory, or resource-related — that the industry must navigate. The series of presentations, interactive discussions, and hallway asides revealed the resilience and the innovation inherent in the data center sector. Let’s dissect some of these trends and how we are grappling with the challenges at the core of our industry.
Market watch
Rising scale is arguably the biggest disruptor our industry is facing. The JLL team, known for their rigorous and insightful quarterly reports, highlights that the current phase of growth is heavily focused on upscaling and innovating efficient solutions. The reality is that right now, there is not enough existing capacity to meet demand, and their estimate of "under construction" data center sites equals all existing sites. Let me say that another way: the in-progress construction will double and, in some markets triple, our footprint.
Traditional markets have to shift. Since primary markets are arguably at full capacity, the industry is pushing toward secondary and tertiary markets to cover increasing demand. Because we are capped on what can fit into major markets in NFL cities, destination pricing is having a significant impact on digital real estate. Markets that will emerge as significant players will be due to their stability, low corruption, and tax incentives, which make them an attractive destination for data center investments.
NoVa used to be half of the data center market in the U.S. While still the dominant market, it’s no longer quite that large, with other markets growing to fill demand. Some markets with reports that stand out: In Salt Lake City, the market size is expected to triple, indicating the massive scale of growth anticipated. In Phoenix, we would see the market explosion, if the power story was not as challenging. At this time there is no opportunity to expand there, but over time the market will come back; and note that Salt Lake City is always about 15% higher than Phoenix. In Texas, the most competitive market is Dallas, though rental rates are still lower in Dallas than in the booming tech city of Austin. Atlanta and the surrounding area are growing, but as the state reconsiders tax incentives, they may lose out on the current industry growth.
The intense supply-demand dynamics have not surprisingly pushed rental rates up, but not nearly as fast as expected, indicating a potential lag in price adjustments to market realities. With vacancy rates decreasing, rents have seen a 23% increase year over year (YOY). The inventory growth stands at a 20% compound annual growth rate (CAGR), only limited by availability. Even secondary markets are seeing a rise in rental rates.
Virtually all available market capacity from a year ago has been absorbed, a trend that is expected to continue due to escalating demands. Notably, 80% of absorption involves less than 10 customers, highlighting the concentration of market power among major players. Demand is largely dominated by hyperscalers, particularly as the market tightens with emerging AI requirements.
Long story, short, our geographical strategy has to shift. Data centers have predominantly been located in NFL cities with established cloud availability zones. New strategic placement suggests a dual approach: sticking to major cities for critical operations while exploring smaller cities for less latency-sensitive functions. These smaller cities are poised to become meaningful mini-hubs, adjusting to the shifting demands of location sensitivity in data center operations.
In summary, the data center market is experiencing rapid growth and transformation, driven by scaling operations and market shifts that challenge traditional models and demand innovative solutions to keep pace with global digital demands.
Financial dynamics
As development timelines extend and technological requirements become more complex, both funding mechanisms and merger and acquisition (M&A) activities are adapting to meet new market conditions, sustain growth trajectory, and meet the global surge in demand for digital infrastructure.
The rapid escalation in data center development is reshaping how funding is approached within the industry. Historically, investors were more hands-off, treating data center investment akin to real estate acquisitions. However, the current landscape demands a more nuanced understanding. Investors are now requiring detailed insights into the designs and technological underpinnings of projects before committing funds. This shift is largely due to the increasing complexity and technological advancements in data center operations, especially as facilities adapt to support emerging AI technologies.
However, these investors are becoming very technically savvy, often demanding detailed plans that demonstrate how a build and design will support specific revenue models, especially those geared toward advanced AI capabilities.
Capital needs for the industry are massive, as development timelines have significantly extended. Where it once took 12-18 months to develop a data center, it now can take up to four years. In past days, tenants had to walk the floor before they would lease; now they can’t wait that long. This shift poses a critical challenge: matching development time frames with investment horizons. If a fund has a five-year horizon and it takes four years just to develop a facility, the window for realizing ROI becomes very tight. This scenario may lead to periods where capital is scarce as investors wait to rebuild inventory for sales.
The industry may need to investigate potential restructuring to better align with these new financial and time-based realities. Concepts, such as separating lending phases between land, development, and yield may need to be considered to match capital investment horizons more appropriately. Private equity continues to be a critical source of capital, with no shortage of funds ready to be deployed. While there is plenty of capital available, aligning it with the right opportunities is becoming increasingly complex.
The M&A landscape in the data center sector reflects the high value placed on these assets. Based on JLL’s capital markets assessment, data centers are currently selling for an average of 26.6 times their earning before interest, taxes, depreciation, and amortization (EBITDA), indicating strong market confidence in their profitability and strategic importance. This high valuation underscores the critical role data centers play in today's digital economy and the aggressive competition among investors to secure valuable assets that promise substantial returns. The M&A activity not only highlights the financial robustness of the data center market but also signals ongoing consolidation as companies seek to scale operations and expand their geographical footprint. As the market continues to evolve, driven by technological advancements and shifting demand patterns, further mergers will play a pivotal role in shaping the industry landscape.
Higher-density deployments
As the data center industry evolves, we're seeing a significant shift in how resources are managed, with cluster sizes decreasing while density increases. This trend supports the development of more efficient, high-capacity data centers that cater precisely to workload demands without expanding their physical footprint. Looking ahead, strategies will likely involve deploying systems later in construction to allow for adaptive density enhancements based on real-time technological needs, instead of locking into designs years out during the planning phase.
Moreover, the trend of cloud repatriation highlights a shift back to private data centers from the cloud, driven by the need for greater control, security, and cost-effectiveness. This movement underscores the evolving preferences of businesses as they seek to optimize their data handling and processing infrastructures in an increasingly digital world.
Navigating the power problem
As data centers continue to serve as the backbone of the digital economy, power has become the critical driver, steering development into new territories and presenting unique challenges. This relentless quest is compelling the industry to confront unprecedented issues and innovate in ways that align with both business needs and regulatory landscapes.
Power acquisition is an undeniable challenge, as recent trends show that companies are willing to pay premiums for land with guaranteed power supply — a necessity that has seen property values quadruple, highlighting the critical nature of power in site selection. However, this need also introduces complexities; instances where power commitments are withdrawn post-agreement are causing substantial setbacks, underscoring the volatility and unpredictability of power availability.
The process of securing power itself has become protracted and complex. What used to be a matter of weeks to conduct power studies has now extended to over a year, with subsequent studies adding additional delays. The elongated timeline is challenging the ability of data centers to plan and scale efficiently.
With servers now operating at approximately 80% capacity — up from historical norms of 30%-40% — the dialogue between data centers and utility companies has never been more crucial. Proactively engaging utilities requires thorough preparation; data centers must present comprehensive plans detailing loads, peak demands, and potential “bring your own” solutions. This approach not only builds credibility but also assists utilities, which often do not have ready-made solutions for the burgeoning demands of modern data centers.
Sustainability remains a pivotal concern, taking second chair to the need for reliable power sources, and providing a viable avenue for power generation programs through microgrid and lower emission or renewable backup-power deployments. Data centers are taking steps to align their energy consumption with sustainable practices, such as using recycled materials in construction and shifting to higher-efficiency fuels. However, the primary focus has shifted to securing any available power, reflecting a pragmatic approach to operational requirements over purely green goals.
The data center industry's ability to innovate in power management and efficiency is remarkable, reflecting a sector that is not only adapting to current challenges but also actively shaping its energy future. Few industries can say as much. As data centers continue to evolve, our role in managing and using power resources will remain a critical element of our operational strategy and a central theme in the ongoing dialogue with regulators, utility providers, and the broader community.
Addressing the talent shortage
As the data center industry rapidly expands, a significant challenge it faces is the looming talent shortage. With about 45% of the current workforce having over 25 years of experience and a large portion nearing retirement, the industry is on the brink of a severe human capital crisis. To combat this, companies must focus on creating more accessible entry points to attract the rising workforce, including simplifying complexities that may deter newcomers.
Strategic succession planning will also be essential, balancing the growth of talent from within with the infusion of fresh perspectives from outside hires. The industry should explore untapped talent pools, such as military veterans and candidates from related fields like power generation and mechanical engineering.
Moreover, the emphasis on soft skills development through mentorship and on-the-job training will be crucial for nurturing well-rounded professionals who can contribute to the industry's growth and skill set to creatively combat the many challenges we face. Retention strategies must underscore the principle that employee success drives customer satisfaction and, ultimately, business success.
In sum, addressing the data center industry's talent needs requires a comprehensive approach that encompasses recruitment, development, and retention strategies, ensuring a robust pipeline of skilled professionals ready to meet the industry's future demands.
Celebrating the time and place we are in
As we stand at the forefront of the digital era, those of us in the data center industry are part of an incredibly dynamic and essential sector. We're not just participating in the market; we are actively shaping a critical infrastructure that delivers invaluable resources to humanity and society. Our work underpins the very fabric of the digital economy, powering everything from cloud computing to advanced AI applications, making it a truly recession-resistant and robust industry.
Despite the uncertainties that pervade global markets, the data center industry continues to demonstrate resilience and capacity for innovation. We are part of a "digital gold rush," where the pace of development is torrid, driven by the relentless demand for data processing and storage. This demand ensures that development thrives wherever there is available power, emphasizing our role in maintaining a balanced supply and demand. In the capital markets, the data center sector continues to witness eye-popping numbers in M&A activities and valuations, reflecting the high confidence investors have in our industry's growth potential and strategic importance.
Our efforts to cater to specialized needs, such as building infrastructures designed around GPUs rather than traditional workloads, highlight our commitment to supporting cutting-edge technology. Moreover, managing operational expenditures begins as early as the commissioning and construction phases, ensuring efficiency and sustainability throughout the life cycle of our facilities.
We need to celebrate that our work in the data center industry means choosing a path that is incredibly impactful. We are enabling a future where digital technologies can flourish, supporting societal advancements and ensuring that essential services remain uninterrupted in an increasingly digital world. Critical infrastructure is just that; and as we look to the future, it's clear that even in the face of enormous obstacles, our contributions will continue to be crucial in shaping the landscape of global technology and innovation. March on, my friends, in our noble quest.
