Data centres: The boom that keeps on giving

Blackstone’s acquisition of US data centre operator QTS for $10 billion in 2021 was viewed by many as a canny real estate play. QTS had a large land bank in a data centre market where there were already too few properties with the required space and access to power to meet growing data centre demand.

Since its acquisition, QTS has upped its properties under development from $1 billion to $15 billion in just two years, and has become North America’s largest provider of leased data centre capacity based on megawatts under contract. QTS’ valuation has more than doubled in the same period to $25 billion by the end of 2023, fuelled by Blackstone committing more cash to future projects.

The Blackstone-QTS marriage is fairly typical. But what started as a real estate play is developing into something else. When Blackstone bought QTS, artificial intelligence (AI) had not entered into the data centre investment equation in a big way. Today AI, and the demands it places on data centres – for example AI server racks can consume four times the power used in cloud processes and require advanced cooling systems to manage the heat generated – is taking data centre development to another level.

Data centre developers did at least $29 billion of project debt volume between 2021 and 2023 in the US according to Proximo Data (see chart). And the numbers only looks set to continue to rise in the next three years on the back of AI demand, a demand that is coextensively fuelling renewables development to meet the growing need for power from the data centre sector.

Home to hybrids

While data centres are now a highly sought-after and recognised asset class, greenfield data centre financing has, from the very start, avoided traditional investment bank labelling. Unlike most asset classes, where one or two types of financial engineering predominate in the greenfield and brownfield classes, no uniform approach or investment bank silo has developed for data centres. Financings are often customised hybrids, borrowing from techniques used in project finance, securitisation, real estate, leveraged finance, holdcos and even borrowing base financings.

But the lack of standardised approach has not and is not impeding the boom in data centre financing, which having spread from the US to Europe, is now also gathering pace in Asia.

Last month EQT-owned Edgeconnex signed on a €1.75 billion five year accordion facility to fund development and acquisitions by its European data centre platform. The deal had little trouble finding bank appetite, with 17 lenders – ABN Amro, BBVA, Rabobank, Credit Agricole, CIC, DNB, KfW IPEX, LBBW, Mizuho, NAB, Natixis, OCBC, Societe Generale, Standard Chartered, TDB, UniCredit and KDB – taking a piece despite a fairly tight margin: 210bp rising to 305bp over the five-year tenor.

Around the same time as the Edgeconnex deal, QTS closed on a major data centre construction facility in the US – a $1.39 billion five-year term loan provided by SMBC, Cobank, MUFG, Banco Santander, Mizuho. Shinhan Bank, CaixaBank, Korea Development Bank, Intesa, CIBC, Industrial Bank of Korea and Woori Bank. The deal funded a 135MW hyperscale data centre campus in Richmond, Virginia.

Two weeks later QTS was back again with another debt signing for data centres on a campus in Phoenix, Arizona. The $1.28 billion five-year construction-to-term loan was provided by SMBC, Mizuho Bank, CoBank, MUFG, Banco Santander, BBVA, Bank of Nova Scotia, Desjardins, DBS, Kookmin Bank, First Citizens and CaixaBank.

Most recently, Vantage Data Centers has raised a $3 billion green revolving credit from a bank syndicate led by Wells Fargo Securities and joint bookrunners TD Securities, Truist Securities and Scotiabank to fund the ongoing development of its North American platform. That deal follows a $6.4 billion equity investment in Vantage led by DigitalBridge and Silver Lake in January.

Size, repetition and flexibility

The common thread between all these deals is size, repetition and flexibility. Size and repetition – and the strong credits that ultimately back the major data centre developers – have enabled major sponsors to build a wide network of relationship banks, with many coming back for repeat business irrespective of the type of financial engineering employed.

That promise of an ongoing and regular deal pipeline will also figure in lenders’ margin and fee calculations, with banks offering fairly generous terms to serial data centre borrowers. In addition, data centre revenue streams (dependent on user contract length) are generally fairly predictable, driven as they are by recurring cashflows from big tech, and increasingly profitable: hyperscalers are now paying data centre operators monthly rates of over $100 per kilowatt, from $70 to $80 per kilowatt three years ago, and in some high demand areas it can even go to $150 per kilowatt.

For data centre sponsors the key financing caveat is arguably the ability to meet multiple and varying project demands whilst maintaining balance sheet flexibility – in effect the ability to scale quickly to meet demand. Of the deal examples outlined, both the Edgeconnex accordion and Vantage revolver anticipate growth, although the former avoids the need to amend legal documentation if debt capacity is increased for additional projects, while the later is effectively an overdraft facility. The QTS deals also offer flexibility in that they are effectively project financings for phases of hyperscale projects.

As data centre portfolios grow, financing strategies also evolve. Vantage was the first US data centre developer to tap the securitisation market, issuing $1.125 billion in securitised notes in early 2018. Eight further deals followed, most recently culminating with Vantage issuing another $1.35 billion of notes in October 2023.

The issue, backed by tenant lease payments from operational Vantage data centres, included $1.026 billion of five- and seven-year class A notes, a C$380 million a tranche and $43 million of class B notes – all arranged by Deutsche Bank Securities, Societe Generale, Truist Securities and Wells Fargo Securities.

The securitisations are used to refinance existing debt on operational assets, thus enabling sponsors like Vantage to free up space for more debt for greenfield projects.

The Proximo perspective

While most stand-alone data centre projects are project financed, the reality is that much of the market is and will remain hybrids, particularly for portfolios that mix greenfield and operational assets. And with data centres being highly capital intensive, diversity of capital sourcing is only likely to increase as AI fuels even more data centre demand and expansion. 

But although access to liquidity is unlikely to become a problem, access to power and land may.

For their power needs, data centre developers, particularly hyperscalers, are subject to the same constraints as the renewables sector – supply chain issues and project delays – whether they are signing external PPAs for pre-operational renewables projects or developing their own renewable power sources.

Similarly, land and access to water for cooling are further potential headaches, with the race for data centre market share forcing developers to buy land without having certainty as to whether the required permits for development will be forthcoming.

Will those risks deter data centre equity investors? Unlikely in the short term – given the amount of appetite for the asset class. Furthermore, the quality of the credits investing in the sector, and the predictability of revenues from the big tech tenants for such projects, mean banks will continue to follow the money. But the physical constraints of land and power could yet put the brakes on the pace of growth in the sector.