I’ve never been a believer in the infamous reports of data center supply shortage. In my mind, “data center shortage” is the number one myth in our industry. From where I sit, there’s a shortage in data center planning and operators, not the underlying facilities. Further, it’s far too simplistic to lump all demand and supply into one big bucket. Today, with infrastructure alternatives multiplying by the day, between cloud, container, colo, and real estate, it’s really important to be specific about the segment in question.
Regardless, I like to start all of my research and custom assessments with the fundementals, from the ground up, using facts and not opinion. I start with broad real estate trends, because all real estate is inter-dependent at some level, whether it’s the availability of equity, debt, or the role real estate plays as a barometer for the direction of the economy as a whole. Can employment increase without a change in office occupancy?
Thus, looking at the office market as one benchmark, it’s important to observe that the construction pipeline is all but shut down and reduced rents are prompting many tenants to trade up for better or more efficient space. The U.S. office market absorbed a strong 19 million square feet in the third quarter, according to data presented this week by CoStar. According to their statistics, the national office vacancy rate dropped a half percentage point to about 13.1% after hitting a peak a year ago. Activity increased in the third quarter as tenants signed long-term commitments to lock in low rents for higher-quality Class A and B buildings after bottomed out in early 2009. According to our primary market research, DATA CENTER ACTIVITY AND PRICING FOLLOWED AN IDENTICAL CURVE, bottoming in the first quarter 2009. The low-point nationally for rents for class A data center space – N+1 concurrently maintainable space in a Tier 1 market – was approximately $125 NNN for 500KW and above.
Focusing on growth markets, the San Francisco Bay area, which has seen some of the most heavily discounted rental rates among office markets, led the country with 4.4 million square feet of net absorption in the third quarter. Similar net absorption strength was found in markets with heavy presence of technology and energy firms. The top five metros for absorption included Seattle/Puget Sound (2.5 million square feet absorbed) Boston (2.1 million square feet), Philadelphia (1.9 million), Houston (1.9 million) and Washington, D.C. (1.7 million). Northern New Jersey led a handful of markets that experienced negative absorption, also including Atlanta, Los Angeles, Westchester/So Connecticut, and Minneapolis.
Are these statistics so different for data centers? Despite massive investment, the Silicon Valley / Bay Area data center market has absorbed huge data center capacity. And, LA and Tier 2 markets have languished, with LA posting some of the cheapest leasing rates nationally.
It’s interesting to note that office tenants are locking in long-term rates. Astute data center investors and lessees should be doing the same, though I haven’t seen the same level of understanding or attention to the business cycle amongst IT buyers as observed within mainstream real estate…a rare example where real estate folks are out in front of the trend.
At the end of the day, the happy story is that More than two-thirds of the 20 largest markets are seeing year-over-year occupancy improvements. Leading the charge is Orange County, CA, which is now recovering after being staggered by the mortgage and financial market meltdown. Is it a coincidence that Latisys, Savvis, Fortune Data Centers and Alchemy are all piling into Irvine? We can debate whether there’s enough demand to absorb all that supply, but at least the trend seems right.
A cautionary sign facing the market is federal cutbacks. If Congress opts for the harshest federal cuts, it could result in 8 million jobs lost. Astute investors will orient their dollars toward markets less dependent on Federal spending, like the Bay ARea, Seattle, Dallas-Fort Worth and Houston, who rely on technology and energy.