Data centres; the new powerhouses of investment ...

‍Introduction

The data centre sector in the UK and Europe continues to see surging demand with unprecedented drive from companies involved in artificial intelligence (AI) development as well as increased cloud storage requirements which is attracting more institutional capital for new developments. This is driving lender and investor interest from a mix of real estate and infrastructure funds who see scalable digital infrastructure as the new investible alternative asset class.

The development of data centre infrastructure presents a complex mix of regulatory, operational and structural challenges. This article explores the opportunities and the challenges in data centre developments and presents solutions that lenders, investors and developers should consider, leveraging the experience and knowledge of Kingswood REA in the sector.

The Opportunity

According to latest market activity capital commitment is robust across both equity and debt, with investor appetite close to the record levels on data centres investment and development.  Data centre investment offers long-term, stable cash flow underpinned by secular growth in digital demand. For lenders it provides opportunities in development financing, refinancing, and green financing products. For investors and developers, the upside lies in development, repurposing assets, geographical expansion, and ESG-driven premium facilities The main opportunities include:

·       Data centres are now classified as mission-critical infrastructure and due to the nature of the facilities it has low tenant churn due to high switching costs.

·       Security of long-term lease where operators and hyperscalers typically sign 10–20+ year leases, providing inflation-linked long-term income.

·       Blue-chip occupiers like AWS, Microsoft, Google, Meta, and major enterprises provide strong covenant strength making it attractive to lenders and investors

·       Data centres are the new alternative resilient asset class as they perform defensively across economic cycles due to inelastic demand for digital infrastructure.

Challenges and Barriers

Whilst capital is available on an asset class that was previously perceived as niche and complex the primary bottleneck for growth are power constraints, permitting and regulatory hurdles and skills shortage.

Power

The exponential growth in demand for data centres requires rapid development in infrastructure to keep pace, and most crucially, infrastructure facilitating access to power. Securing power is a critical prerequisite before acquiring land for a data centre development. Sites that have power readily available are commanding higher prices. Where power upgrade is necessary significant investment is required and timescale is crucial for early negotiations with the relevant utility companies to get ahead of competition.  Acquiring land for data centre development without guaranteed power supply is highly risky and makes it challenging to attract investment capital. Based on available data and current trends in theUK and Europe the timeline for securing power on a data centre development site can be anything from 2 to 4 years depending on location.

Regulation

Data centres, mainly hyperscalers, are under increasing scrutiny for their energy consumption and sustainability practices. Whilst there is stringent prevailing legislation in Europe mainly by EU Energy EfficiencyDirective (EED) the UK is not bound by EU law but has similar planning and energy efficiency policies and regulations that significantly impact data centre development and operation.  

Data centres are being benchmarked on their power efficiency and energy sources, prompting data centres to explore onsite energy generation and direct power purchase agreements. As part of the evolving regulatory framework across all jurisdictions there is increasing pressure on data centres to source their power from renewable energy sources which is not always the most practical or economic options. The reliance on non-renewable energy sources and offsetting through green credits cannot be seen as a long-term option as the sustainability regulations tighten up and this will limit and slow down new developments in the sector.

Momentum toward renewable energy transitions, including on-site solar, wind, geothermal and modular nuclear, will accelerate as developers and operators aim to de-risk power strategies and meet long-term sustainability targets.

Skills Shortage

The construction industry is already suffering a skills shortage and this is exacerbated in the data centre sector where it is predicted that circa 100,000 trained engineers will be required in the next 5 to 7 years to design, build and operate data centres globally. Training programs are on the way at various levels however it does take time and the gap in the meantime will mean that the sector cannot cope with demand and this has two main impacts i.e. increase the cost of qualified people and delay in getting projects off the ground and completed due to limited resources.

De-risking strategies for developments

To address the complexities involved in data centre developments the following key considerations are required for developers to reinforce lender and investor confidence in the asset class:

Strong Local Partners

It is crucial for data centre developers to have strong local partners to manage negotiations with statutory authorities such as local planners, council officers and power, water and telecom providers. Building and establishing strong relationships with key players that can facilitate the development of complex and capital-intensive critical infrastructure is a no brainer and will significantly help de-risk any new developments. Any data centre developer who achieves this in the markets that they operate will have the competitive edge and will provide increase confidence to their financial backers and will be seen as established players in that segment of the market.

Optimum Procurement Strategies

Data centre construction is capex intensive and a typical build is usually significant in value with the associated building services commanding the majority of the costs. Approximately half of the building services budget is attributable to the major equipment required to run a data centre. These include cooling equipment, heat rejection, electrical main switchgear, uninterrupted power supplies (UPS), and power generators, etc. As these amount to a significant budget in their own right, and most of these require long manufacturing slots and lead-in times, there are several procurement routes adopted that have become standard within the industry that help de-risk the construction phase as below:

1.      Traditional –Contractor procured

2.     OwnerFacilitated, Contractor Installed (OFCI)

Based on various on-going developments there is clear evidence of a commercial benefit to the developer from an OFCI procurement route as opposed to a traditional or design and build route under aMain Contractor arrangement.  The OFCI strategy provides a more commercially beneficial option as well as improving procurement and construction timescales which is crucial on pre-let transactions. Notwithstanding the above the following points need to be considered:

·       Risk profile of direct purchased equipment in terms of design and contract responsibilities.

·       Interface schedules (RACI matrix) for supply, installation and commissioning of major equipment.

·       Framework agreements and post contract services for maintenance of critical equipment and for future phases of potential expansion.

Security Package

To address the complexity in data centre developments, funders are increasingly requiring contractual assurances, including guarantees, that a data centre project will be completed on time and within budget, with delays or cost overruns triggering covenant breaches or funding suspensions.

Generally Main Contractor track records and key specialist contractor in the sector need to be heavily scrutinised with a high level of transparency to limit the risk of insolvency.

Step-in rights for funders, allowing them to take control of the project if the developer defaults or fails to meet key obligations. The step-in rights frameworks should also include continuity plans in the event of any contractor failures to ensure that a strategy is in place to mitigate any disruptions in the event that any contractor within the supply chain goes under to safeguard the cost and programme of the development as much as possible.

Future-proofing against obsolescence

Developers need to adopt early strategies to reduce the risk of obsolescence, such as designing flexible data centres that can adapt to future technological changes. The challenge lies in balancing the capital-intensive nature of building data centres with the potential that technological advancements might render them less valuable in the near future. However, a proactive approach of demonstrating that data centre developments can be future-proofed to a certain extent will enhance the confidence of any investor or lender appraising in investing in their future pipeline of projects.

Conclusion

The data centre sector presents major opportunities for lenders and investors but is underpinned by complex technical, regulatory, and operational risks. Success in this market requires early, proactive risk management strategies particularly around power, procurement, contractor resilience, and sustainability. Developers who can demonstrate strong partnerships, resilient delivery strategies, and credible future-proofing will gain the competitive edge and instil greater confidence in their financial backers.

To find out how Kingswood supports lenders, investors and developers in the data centre sector, please get in touch.

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