Struggling Energy Sector Dampens Demand For Houston’s Data Centers

Houston boasts a large population and some serious economic clout, but the data center market remains significantly smaller than those in other U.S. cities.

Most providers are serving local customers, rather than huge, global cloud firms that are boosting growth elsewhere. Of those local customers, the oil and gas sector remains dominant, accounting for half of all data center demand in Houston.

However, the economic double whammy of the energy downturn and the coronavirus pandemic has dampened that demand.

Houston’s data center supply was 1.1M SF during the first half of 2020, with about 202K SF of that space sitting vacant, according to the latest outlook report from JLL.

Energy sector users account for about 50% of data center demand in Houston. The next largest sector is banking and financial services, at 25%. Healthcare uses 15%, while the remaining 10% is driven by technology companies, JLL found.

There are no data centers under construction in Houston, though about 582K SF is planned. Until vacancy levels improve, providers are holding off on increasing the supply, according to JLL.

Historically, oil and gas companies in Houston had their own data centers, known in the industry as enterprise facilities. But over the past five years, there has been a greater shift toward finding more efficient and cost-effective solutions. As a result, more firms are opting for co-location services, in which companies house privately owned servers and networking equipment in a third-party data center. Other companies have adopted a hybrid approach, using co-location services as well as keeping some internal systems.

“It's very expensive to build data centers. It typically costs an enterprise company over $20M per megawatt to build a data center. And we do it for about a third of that, maybe 35%, 40% of that,” CyrusOne Vice President of U.S. Enterprise Sales Fred Holloway told Bisnow.

“When you build a 300K SF facility that can draw upwards of ... 40, 50 megawatts, you're building at a very different scale than most corporations.”

By going to a co-location provider, companies can avoid expensive capital investments and cut back on their utility bill. It can be a handy solution for growing users that don’t have a long-term idea of how much power or space they need.

Stream Data Centers Vice President, Network and Cloud Chad Rodriguez said that in light of the pandemic, many firms are taking a good look at their operations and trying to figure out how to improve resiliency.

“I think you have a lot of IT firms, or IT organizations within enterprise, who are revisiting ... how their organization operates. And what I mean by that is, it's not just a total cost of ownership ... but it's also about developing resiliency, it's about leveraging the cloud,” Rodriguez said.

The other factor attracting more users is data security. Holloway noted it is expensive to maintain facilities that are compliant with the Health Insurance Portability and Accountability Act, known as HIPAA. The same goes for facilities that are compliant with the Payment Card Industry Data Security Standard, known as the PCI Standard, which protects payment card data. 

That expense has led to a significant increase in the number of financial services and healthcare companies using data centers.

“Right now, healthcare and financial services both have significant regulatory issues that they are addressing and dealing with. And I would say, those are the two industries that we probably see the largest demand from right now,” Stream Data Centers Executive Vice President and partner Anthony Bolner said.

Houston has about 40 data centers across the city, according to Deloitte Transactions and Business Analytics Managing Director Michael Hostettler. The majority of those facilities are co-location service providers. Despite the size of the metro, Houston is a much smaller market in terms of megawatt total absorption than booming hubs like Northern Virginia or Dallas-Fort Worth.

The city recorded net absorption of 1.3 megawatts during the first half of 2020, JLL’s outlook report showed, and 19.3 megawatts remained vacant. Megawatts are generally considered a more accurate way to quantify data center use than occupancy tied to square footage. In comparison, Northern Virginia absorbed 180 megawatts in the first half of the year. That area has 13.8M SF of data center facilities, with 3.9M SF under construction, JLL said.

Holloway said that if a company isn’t already based in Houston, it is unlikely to go out of its way to use a data center within the city. The perceived risk posed by hurricanes and flooding can be a major deterrent for companies unfamiliar with the region. For that reason, energy companies have traditionally dominated Houston’s data center usage.

“If your company isn't headquartered here, it doesn't have a major operation here in Houston, you probably aren't going to look to the Houston market. And the reason is, it's all about the hurricanes,” Holloway said.

He feels that risk may be a bit overblown.

“Ironically ... hurricanes are one form of natural disaster that you can predict. You know when they're coming, and you can make whatever adjustments you need to operationally, ahead of time.”

Hostettler said that despite economic and environmental risks, Houston has maintained one of the largest U.S. ports and sustained moderate to consistent growth in the real estate industry.

“While Houston has some potential weather-related challenges, such as flooding, the risks are well understood and closely tracked so that they can be managed,” he said.

The aggressive growth of data centers in other U.S. markets is being primarily driven by cloud demand. It accounted for 80% of data center demand in Northern California and 58% of demand across the northwest U.S. during the first half of 2020, according to JLL.

Conversely, the report indicated that the cloud did not account for any demand in Houston during the same period. Despite those findings, both CyrusOne and Stream Data Centers said they have cloud customers in the city and are equipped to facilitate growing cloud demand.

CyrusOne was founded in Houston in 2000, and over the past two decades has grown to be one of the largest data center companies in the country. At the start, the majority of CyrusOne’s customers were in the energy sector, and even less than 10 years ago, that industry accounted for more than 50% of the company’s revenue.

In a sign of the times, it’s now the biggest cloud users, or hyperscalers, that account for the majority of the company’s revenue, at about 45%.

The performance of Houston’s broader industrial market has outshone other real estate sectors during the pandemic. As shopping habits have shifted online, e-commerce demand has skyrocketed. That is being reflected in an uptick in demand for data center providers across the country, including Houston.

“It drives growth on the enterprise side, but it absolutely drives growth on the cloud side. No question,” Bolner said.

That demand is also attracting interest from the capital markets, as investors seek opportunistic places to put their money. The interest is not just in the already-booming markets, but others that are pinpointed as growth markets of the future. They include places like Las Vegas and Hillsboro, Oregon.

“There's capital that wants to develop. There's capital that wants to buy stabilized assets. It's just the nature of the timing of the market,” Bolner said.

In terms of Houston’s own future growth, the JLL report said that once the energy industry begins to recover, the forecast for the Houston market will improve. Supply is not the issue in Houston — it’s the lack of demand, which is driving providers to lower their pricing in an attempt to compete for users.

“Providers with the ability to quickly add to supply may benefit as the market recovers,” the report said.