Power outages have made it more difficult than ever to accurately assess the value of potential data center sites, posing a significant risk to developers scrambling to secure the land needed to meet record demand.
Bisnow/Provided with support from Google Gemini
For third-party data center companies that buy thousands of acres of land to lease buildings or entire campuses to companies like Amazon Web Services, Microsoft and Google, getting to market quickly is key. The world’s largest technology companies, locked in an AI arms race, need more data centers — now. They’re snapping up new data center capacity as fast as it can be built and leasing planned inventory before construction begins.
These tech giants insist that developers deliver expected capacity within tight deadlines. But over the past year, unexpected power shortages in most major U.S. data center markets have delayed grid connections and made it increasingly difficult for developers to determine how quickly new inventory can be brought to market at a given location.
This unpredictability in terms of time to market has made determining the value of potential development sites significantly more difficult and dramatically increased the risk that companies will overspend on sites that remain undeveloped for much longer than expected.
The data center industry may be experiencing an unprecedented construction boom, but industry executives – speaking at Bisnows DICE: South event this month at the Westin Galleria Dallas – said the ability to accurately estimate time to market and limit risk exposure will determine winners and losers in the ongoing data center rush.
“The capital markets, the real estate markets, private equity – there are 800 different ways to invest in development, and people are going to get their fingers burned if they don’t do things right,” Dave Ferdman, president of Primary Digital Infrastructure and former co-founder of CyrusOne, said at the event.
“I think a lot of real estate investors will get their fingers burned.”
As the AI-driven data center arms race drives up power demand beyond utility expectations and strains regional transmission grids, there is almost no land left in attractive data center markets that offers immediate access to the massive amounts of power that data centers require. The few sites that can be delivered immediately are leading to bidding wars among the big tech companies and commanding huge prices. In the vast majority of cases, however, third-party developers are now acquiring land that may not have adequate grid connectivity today but that they believe will have power in the near future.
For the largest data center developers, who are pouring billions into the land reserves of major data center markets to keep up with demand from big tech companies, this is not a purely speculative endeavor. The evaluation of potential data center sites depends largely on how well the site’s power connection is secured. Developers are willing to shell out significantly more if the utilities have committed to providing the required power within a set time frame. This is especially true since big tech companies now routinely pre-release their data center capacity before these land deals are even finalized.
With wait times for new grid connections now exceeding two years and up to seven years in some markets, building sites that can be connected more quickly are attracting higher valuations.
But experts say over the past 12 months it has become much more difficult to understand and predict how quickly a potential data center development site can be powered.
Until recently, a utility’s “will serve” letter – a document promising a grid connection and a certain amount of power within a certain time period – was treated as a virtual contract by data center developers, investors and tenants. If a utility promised that a site would have power in 18 months, that was it. These supply commitments were enough for lenders to finance projects and for tenants to pre-approve the capacity to be built on the site.
But now utilities have begun routinely delaying the delivery dates promised in those original power contracts. As utilities rush to upgrade their infrastructure to meet an unexpected wave of energy demand from data centers, they can no longer rely on the delivery dates provided by utilities, said Ferdman and other executives at DICE:South.
For developers looking to secure land ready for development quickly, this increasing unreliability poses significant risk to each such transaction. Paying higher prices just because a utility company promises a quick timeline can be a big mistake.
“We’re at a point where a large developer is very likely to get a call or a goodbye letter saying, ‘Sorry, you’re not getting 40 megawatts next year, you’re getting two,'” Ferdman said. “The likelihood of power delivery is getting smaller and smaller. So who’s going to develop a site if they don’t know the power is there?”
However, this uncertainty around access to electricity is not the only trend that is making time to market increasingly unpredictable. It is also making proper site assessment more difficult and posing significant risks for project developers.
In addition to factors such as ongoing supply chain delays and labor shortages in construction, panelists at DICE: South pointed to community resistance and a hostile political landscape in a growing number of industrial centers. Timelines for permits and entitlements are becoming less predictable, and local resistance can delay or derail projects.
“Power is the most important thing here. But when we deal with zoning or easements, those can also extend the lead time,” said Elizabeth Yaeger, a data center lawyer and shareholder at Greenberg Traurig. “Those risks need to be mitigated contractually and built into the timeframes you promise.”
Bisnow/Katy Frazier
Dave Ferman of Primary Digital Infrastructure speaks at Bisnow’s DICE: South in Dallas on August 7. Joining him are (left to right) Carrington Brown of Affinius Capital, Jeffrey Moerdler of Mintz, Fran Federman of CyrusOne and Karlton Holston of Landmark Dividend.
The increasing challenge of accurately estimating time to market puts developers at increased risk of buying properties that may never deliver the expected return. But it also increases the amount of capital developers must put into a property before and after the actual purchase, says Rafal Rak, vice president of portfolio management at Digital Realty.
Before acquiring a potential data center site, developers today must invest much more time, manpower and money in the necessary due diligence and analysis to understand the local and regional grid infrastructure and accurately assess energy delivery schedules. Understanding the political landscape and identifying potential permitting or entitlement risks early on also requires more effort than ever before.
Once a property is under contract, developers now routinely make significant upfront investments to ensure the property has power as quickly as possible. In some cases, this means building a power plant on-site, which, while not producing all the power tenants ultimately need, can serve as a stopgap until the property can be served by a utility. Increasingly, developers are partnering with utility companies to shorten delivery times by building substations or other necessary transmission infrastructure themselves.
“You really have to get proactive and do a lot of upfront work to establish, secure and assure power supply, and that means a lot more (capital expenditure) up front,” Rak said. “Many of us don’t like to spend money speculatively without some kind of commitment from the provider, but we’re seeing that becoming an increasing reality. You can’t just buy a site and think you can successfully lease it without doing that.”
While acquiring land for development is more of a gamble today than in the past due to increasingly unpredictable power delivery dates and shorter time-to-market, the success or failure of developers’ land banking strategy does not depend on luck, DICE:South executives said.
The odds, they say, are in favor of established players with a long track record and an understanding of grid infrastructure, operations and utility-scale grid demand. Successful companies can also leverage their close relationships with utilities to better anticipate potential delays and work proactively to mitigate them. Executing projects often requires the sophistication and capital needed to successfully finance and deploy on-site power generation when required.
In addition, developers are increasingly structuring their land deals by passing the risk on to the previous landowner. This approach will be critical to successful land strategies as power becomes increasingly unreliable, says Jeffrey Moerdler, a longtime data center attorney and member of Mintz.
“You can lock in the price of the land with an earn-out, where you pay a certain price per acre at closing and then when and if you get the power, the seller gets a post-closing bonus,” he said. “I’ve done several deals like that.”
As data centers outperform other asset classes and a flood of capital seeks opportunities in the sector, developers from other parts of the commercial real estate sector are turning their attention to digital infrastructure, buying up land and applying for grid connections with plans to develop those sites as data center campuses. But many of these new entrants may feel out of their depth, said DICE panelists, stuck with overpriced land that may not be powered up quickly enough to catch the unprecedented wave of data center demand before it crashes.
“It used to be that anyone who had an old Walmart was sure they had the nearest data center, and our phones would blow up every day a Kmart closed,” Ferdman said. “Zero percent of them became data centers, and a lot of capital was lost. In today’s world, I think that’s where a lot of money is going to be lost.”
