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From boring to booming
YOU know there's money to be made from investing in data centres, when one of Singapore's most astute investors and tycoon Oei Hong Leong is throwing his weight behind a US$5 billion fund aimed at developing an ecosystem of data centres. These staid buildings, housing vast banks of networked computer servers that power the global economy, are now looking attractive to a broad spectrum of investors. What used to be a niche asset class is now almost mainstream real estate. While not the sexiest of businesses, data centres have become crucial infrastructure in an economy where data consumption and mobile penetration is steadily rising, businesses have gone digital, and everything is "in the cloud".
Operators of data centres are capitalising by ramping up capacities globally to meet exploding demand. Institutional investors have been quick to sniff out the opportunities, and the likes of Blackstone, Singapore sovereign wealth fund GIC, Mapletree Investments and Keppel Corporation have already jumped into the sector.
Singapore's state investment agency Temasek Holdings too is enlarging its exposure in this sector, with news reports in February saying it was seeking to buy Australia-listed NEXTDC.
For retail investors, in the real estate investment trust (Reit) space, data centre Reits continue to be standouts, says Tom Duncan, CBRE executive director for data centre solutions, advisory and transaction services in the Asia-Pacific. On average, listed data centre Reits globally are up 24 per cent year-to-date and have returned more than 60 per cent over the past two years.
What is it about these boring buildings - which could be described as very expensive warehouses - that has made investors sit up and take note?
The Asia Pacific region is predicted to become the biggest data centre market in the world in 2020, according to CBRE Research. PricewaterhouseCooper puts market growth in the double-digit range, at over 20 per cent a year.
Analysts point to stable income streams, relatively long lease commitments - at least five years on average from blue-chip tenants compared to the three-year average for commercial leases - and stickiness of occupiers.
Cushman & Wakefield notes that the average capitalisation of 6.5 per cent for data centres serving high-quality tenants is deemed attractive, compared to commercial and residential real estate currently yielding below 5 per cent.
That's despite the construction costs, hefty capital expenditure and complexity of operating mission-critical data centres - all high cost factors that pose formidable barriers to entry to this asset class.
Construction cost for new data centres can run from US$100 million for a multi-tenanted facility to as much as US$1.5 billion for a cloud campus housing several buildings, notes Lynus Pook, associate director for Data Centre Advisory Group at Cushman & Wakefield. Of the total gross development value, land cost typically makes up 20- 30 per cent, Mr Pook adds. The remaining cost goes to constructing mechanical and electrical equipment, including generators, chillers and transformers, with a shelf life of between 10 and 25 years.
Key players ramping up in Asia-Pac
Costs notwithstanding, global players are on expansion mode, looking to add capacity particularly in the fast-growing Asia-Pacific sector.
Data centres were originally built, owned and operated by individual enterprises. Many data centres are also run by Internet service providers for the purpose of hosting their own and third-party servers.
The sector has shifted from the ownership model to a subscription and capacity-on-demand model. Increasingly, the adoption of "co-location" - where customers pay a monthly or annual rental fee for the space and basic infrastructure-level support in carrier-neutral facilities - is spurring the building boom of such data centres.
"Across the Asia-Pacific, we have seen almost all of the demand for new data centre development sites coming from co-location operators who are looking to capture enterprise and cloud customers," says CBRE's Mr Duncan.
Frost & Sullivan industry analyst Ng Yu Xuan agrees, saying many global public cloud providers are significantly increasing their take-up of outsourced data centre capacities in the Asia-Pacific in recent years.
Most of the 150 megawatts (MW) of new data centre capacity added in 2016 and 2017 in Singapore was built for wholesale deals, driven by high demand from cloud giants, she adds.
Networking platforms, tech companies and financial institutions are also key consumers.
Digital Realty, a US-listed Reit that builds, owns and operates data centres, and Singapore-headquartered ST Telemedia Global Data Centres (STT GDC), the data centre arm of Temasek unit ST Telemedia, are among those that have identified cities in the Asia-Pacific to build more data centres.
"We have provided guidance to spend US$1 billion for global development in 2018," says Krupal Raval, Digital Realty's chief financial officer for the Asia-Pacific. "In the Asia-Pacific, specifically, this will include build-outs in Osaka, Sydney and Melbourne." The region houses just 12 of its 205 data centres worldwide, but is the group's fastest-growing market, with Singapore, Hong Kong, Sydney, Osaka and Tokyo all growing at significant rates.
In Singapore, Digital Realty is looking to build its third data centre, as its current Jurong West facility has reached full capacity while its Loyang Way data centre enjoys a healthy occupancy rate of over 70 per cent.
STT GDC has also started building its sixth data centre here located in Defu Industrial Estate in the east of Singapore. It is ramping up its capacity in each of its key markets in the next five years, with more than 10 data centres currently under construction.
India and China are two countries where data centre demand far outstrips supply, STT GDC group CEO Bruno Lopez points out. In China, its associate GDS Holdings is rolling out more space this year in key Tier-1 cities such as Shanghai, Beijing, Shenzhen, Guangzhou and others.
In India, where demand is greatest in the key economic cities of Mumbai, Delhi, Chennai and Bangalore, STT GDC is - through its partnership with Tata Communications - in advanced planning stages on securing new assets, adds Mr Lopez. Of its more than 60 data centres managed through its joint ventures, some 34 are located in China and 16 of them in India.
"Despite the demand, businesses across Asia remain under-served as compared to the US and Europe," Mr Lopez says. "This represents a significant opportunity for us to support our customers' growth and expansion into the region."
Data centre capacity in the Asia-Pacific was 27 MW per million of the urban population as of September 2017, compared to Europe's 56.1 MW per million of urban population, CBRE Research estimates show.
Consequently, rents charged by Asia-Pacific operators in Tier 1 or developed markets are 20-40 per cent higher than those in the US. But some of the developing markets in the region are charging similar, if not slightly lower, rents than those in the US, CBRE's Mr Duncan says.
Between 2017 and 2020, there may be a total of 1,110 MW to 2,220 MW of new supply across the Asia-Pacific, CBRE Research estimates.
Some 34 million sq ft of space will be needed to accommodate this additional supply. More than two-thirds of new supply will be built outside Tier 1 data centre markets over the next four years, mostly situated in China and India.
For those looking to grow their data centre business in the Asia-Pacific, a Singapore presence is regarded as essential, but high land prices can be a challenge.
Singapore also has one of the highest costs in the world for utility and dark fibre, which directly connects one data point to another, Mr Pook adds. But Singapore still beats many regional markets in terms of reliability in power and connectivity.
In South-east Asia, Frost & Sullivan's Ms Ng notes that Singapore and Malaysia have become saturated, resulting in some pricing pressures. Singapore's rates have come down by 15-20 per cent from 2013-2014 due to new supply, C&W's Mr Pook says. Ms Ng sees Indonesia and Thailand as presenting the strongest growth, with the banking and financial services sector driving the take-up of co-location services.
Where smart money goes
Private funds with lower risk appetites have gravitated towards the more mature data centre markets of the US, Europe and Australia so far.
Several major funds were reportedly eyeing Australian data centre services provider Metronode, before it was snapped up by Nasdaq-listed co-location player Equinix for US$804 million in December from Ontario Teachers' Pension Plan.
GIC said in February that it has formed an investment vehicle called EdgeCore Internet Real Estate with US investment firm Mount Elbert Capital Partners and Canadian pension fund OPTrust, to build and operate data centres across North America. EdgeCore is initially capitalised with over US$800 million of equity, which could translate to some US$2 billion in data centre development and investment on a leveraged basis.
GIC Real Estate chief investment officer Lee Kok Sun says: "As a long-term investor, we remain confident in the data centre sector as we expect strong secular trends in data consumption, growth of the public cloud, and the increasing need for connectivity to drive strong demand."
Mapletree Investments in December completed the acquisition of a portfolio of 14 data centres in the US for US$753.8 million in a joint venture with Mapletree Industrial Trust (MIT).
A Mapletree spokesman points to sturdy growth in established data centre cities, including Dallas, New York/New Jersey and Atlanta, as well as growing demand in secondary locations that are benefiting from a shift as costs rise in the established cities. In Europe, cities such as Frankfurt, London, Amsterdam, Paris and Dublin also offer attractive investment opportunities.
Buoyed by contribution from the US data centre portfolio and build-to-suit project for HP Singapore, MIT reported a 2.4 per cent year-on-year rise in distribution per unit (DPU) to 2.95 Singapore cents for the fourth quarter ended March 31, 2018.
The Keppel group, meanwhile, is invested in key data centre hubs across the Asia-Pacific and Europe through Keppel Data Centres, Alpha Data Centre Fund (ADCF) and Keppel DC Reit - Singapore's only pure-play data centre Reit.
ADCF's initial closing of US$1 billion translates to a potential aggregate assets under management of US$2.3 billion on a fully invested basis. The ADCF is currently invested in two data centres in Frankfurt and Singapore.
Keppel DC Reit, sponsored by Keppel Telecommunications & Transportation, has also grown its portfolio by more than 50 per cent since its listing in 2014 to about S$1.65 billion. Its current portfolio comprises 14 data centres spanning 10 cities in eight countries in the Asia-Pacific and Europe.
Its latest quarterly results showed a DPU of 1.80 cents for the first quarter ended March 31, which was 3.4 per cent higher than the year-ago adjusted DPU of 1.74 cents, after excluding the one-off capital distribution that arose from the acquisition of data centre Keppel DC Singapore 3 in Singapore last year. This translated to an annualised distribution yield of 5 per cent.
Riding the wave
As the world's largest and most established data centre market, the US has five data centre Reits - namely Equinix, Digital Realty Trust, CyrusOne, QTS Realty Trust and CoreSite Realty Corporation - with a total market capitalisation of around US$64 billion. On average, they yielded total return of 28.43 per cent last year, according to Nareit, which represents US Reit members and tracks the sector with research and indices.
For investors considering where to plough their capital into, one major factor to consider is the tenant profile of the data centres.
The growth of hyperscale cloud vendors such as Microsoft, Google, Amazon, Facebook, Alibaba and Tencent means that these are highly coveted tenants that will be a boon to the centres they choose to locate at.
These hyperscale cloud vendors are building their own cloud data centres. By 2020, hyperscale data centres will house 47 per cent of data servers globally, and around 70 hyperscale data centres are planned for deployment across Asia-Pacific over the next three years, according to Cisco research.
At the same time, the cloud vendors are also renting more capacity from third-party co-location providers, not cutting down their demand, market watchers observe.
The rise of edge computing - which allows data produced by Internet of Things devices to be processed closer to where it is created instead of sending it across long routes to data centres or clouds - also means there is a need to handle increasing data loads at the edge.
Operators that can win the market will be those who can provide high-density power racks and energy efficiency at affordable pricing, says Ms Ng. In running data centres, cooling accounts for 35-45 per cent of total energy consumption, and there is greater demand for high-efficiency cooling for higher density power racks, says Anand Sanghi, president for Asia at Vertiv (formerly Emerson Network Power).
Mr Pook adds that the race is for those who can offer flexibility and speed for tenants to scale up quickly.
With the rise of cybersecurity threats and data becoming a strategic asset, there are enterprises that deem it fit to build their own gear for mission-critical workloads.
Last month, OCBC unveiled its purpose-built data centre in the east of Singapore costing S$240 million - the first Singapore bank to do so. This data centre is also the first in South-east Asia to have one technology command centre monitoring and managing both cybersecurity and day-to-day operations of core IT systems.
This data centre will cater to OCBC's business needs for the next 30 years. Eugene Lau, head of group technology services at the bank, says the monthly cost of operating its own data centre (partly inclusive of a depreciation charge on the hard asset) is significantly lower than the S$60-S$80 per square foot per month charged by a co-location provider.
"Beyond the issue of cost, having its own data centre also allows the bank to have absolute control of security and physical access," Mr Lau says. This will eliminate the risk of unavailability of space or capacity in the future, hard rental negotiations for renewals, and the risk of ending up with non-contiguous space to host all its servers.
Cognisant of the ever-changing needs of its clients, Digital Realty's Mr Raval notes that data centres will need to evolve into an ecosystem of digital centres, where services exist to complement one another for greater inter-operability.
For now, it seems that the business is as invulnerable as the data fortresses that the centres are meant to be. While rates may come under some pressure in maturing markets, growth prospects remain strong.
"Overall, we foresee that the demand for data centres will only continue to rise," says Mr Raval.