Rental reversion and lower lease rates are challenging data center operators to achieve revenue growth.
Older data centers may become obsolete as they struggle to meet current power and cooling requirements.
Deep dives
Competitive Landscape and Challenges in the Data Center Sector
The data center sector is facing challenges due to intense competition and changing dynamics. Rent rates are decreasing annually, impacting revenues of existing data center owners, such as Digital Realty and Equinix. Additionally, the sector is experiencing a flood of outside capital, including private equity firms, which is driving up supply and creating pricing pressure. The low interest rate environment has fueled this influx of investment, but rising construction costs and tight labor markets are impacting the economics of the sector. Moreover, the impacts of COVID-19 and the pullback in spending by technology companies are contributing to uncertainties in the sector.
Hyper Scale Cloud Providers and their Impact on Data Center Operators
The growth of the public data center sector is heavily influenced by hyper-scale cloud providers like Amazon Web Services, Microsoft Azure, and Google Cloud. These providers are the main drivers of revenue growth for data center operators, but there is a distinction between volume and pricing. While leasing volume may show growth, pricing power is declining due to the bargaining power of hyper-scale cloud providers. They exert pressure on data center operators during lease renewals, leading to rental reversion and lower lease rates. This makes it challenging for data center operators to achieve revenue growth.
Challenges and Obsolescence Risks in the Data Center Space
Data center operators face challenges and obsolescence risks as the sector evolves. Older data centers may become obsolete as they struggle to scale up to meet current power and cooling requirements. Construction costs are rising, affecting the cost side of the economic equation. Land prices for data center development are record-high, particularly in markets like Northern Virginia. Additionally, changing location preferences for fiber optic connectivity impact the relevance of certain data center locations. Retail colocation providers face additional challenges due to shorter duration contracts and the impact of interest rate rises.
Impact of Easy Money and Venture Capital on Data Center Demand
Data center demand has been influenced by the availability of easy money and venture capital funding. During the COVID-19 pandemic, increased online activity and funding for tech startups resulted in heightened demand for data centers. However, as funding tightens and unprofitable startups reconsider spending, the demand for data centers may be affected. The concentration of data center usage by major cloud service providers like Amazon Web Services further influences demand dynamics. The future growth rates of large cloud providers like Amazon Web Services may slightly slow down, but the overall outlook remains positive for the sector.
