Despite Booming Demand, Data Center Developers Face Difficulty Landing Early-Stage Financing

Data center developers need more upfront cash than ever before. But accessing the liquidity needed to navigate the earliest stages of data center projects has become far more challenging. 

The data center industry may be in the middle of a global building boom, but developers face an increasingly difficult landscape in accessing the capital they need for the most risk-loaded phase of data center projects: acquiring land and securing power and other critical infrastructure. 

The quantity of capital required to navigate these early steps in the development process has ballooned, as has the complexity of executing those steps.

Developers looking to obtain that capital face a chicken-and-egg scenario: They typically need a tenant lined up to obtain power and capital, but many tenants won't commit to a project that doesn't already have power secured. Raul Saavedra, head of the Americas data center advisory practice at Colliers, said developers are forced to pull off a “triple Lindy” to secure power, a tenant and financing.

“It’s very difficult to get speculative financing right now,” Saavedra said. “Those days are kind of over.”

This dynamic has helped drive fundamental shifts in the data center investment landscape away from specific projects and toward data center operating companies. But some industry players expect new solutions will emerge in the coming months to help bridge this financing gap for individual data center developments.

“The tough part of this business is that risk part in the beginning. Everyone knows that those predevelopment dollars are the riskiest part of the capital stack, and that's where we're seeing some pushback from the capital and markets and the investors who want to come into this space,” Adam Krupp, managing director at Wharton Equity Partners, said at Bisnow’s DICE Southeast event earlier this month. 

“But I think you will see it start to change as the business evolves and more players want to get involved. You'll see a different perspective as far as how these projects get capitalized.”

As the data center sector has experienced unprecedented growth over the past five years, land that already has access to the necessary power and infrastructure has become scarce. Developers building large-scale campuses now buy land and then must navigate the process of acquiring power and ensuring the site has network connectivity and other critical infrastructure. These sites are then typically preleased to a tenant — often one of the Big Tech hyperscalers — at which point facilities can be built to that end user’s specifications. 

Without a tenant already in place, it is nearly impossible for developers to find financing for a data center project. But over the past 12 months, putting the necessary pieces in place to land a tenant commitment has become far more complex and unpredictable. 

Acquiring power is by far the most significant source of this uncertainty.

As recently as two years ago, developers in most markets could reliably expect a utility to connect a well-positioned site to grid electricity on short, predictable timelines. Today, as the power requirements of data center campuses grow from dozens of megawatts to hundreds and the industry’s rapid growth strains the capacity of grids in most U.S. markets, getting power to a site has become more complicated and the timelines less reliable.

Grid connections in most markets now take years as utilities build out new infrastructure to meet surging demand. Many utilities are also creating far more intensive application processes for power as a way to weed out projects that are unlikely to be viable.

Developers and investors are broadly skeptical about the accuracy of the timelines utilities provide, as they are subject to change due to delays in infrastructure projects or because certain projects are prioritized in interconnection queues. As a result, tenants and investors increasingly need to see that developers already have power in hand at a site.

“From an investor standpoint, there needs to be a commitment to power, not just that you're in a queue somewhere, because you can't do anything if the utility doesn’t give it to you,” Legacy Investing President Daniel English said. “From a capital risk standpoint, that's the big one.”

Power isn't the only factor making it harder to get sites tenant-ready.

Artificial intelligence is complicating the network connectivity needs for data center campuses, often requiring additional due diligence and improvements to fiber infrastructure that wouldn't have been necessary just a year ago. Similarly, the entitlements process is becoming lengthier and less certain as developers face an increasingly hostile political and regulatory environment in many markets. 

Clearing these predevelopment hurdles isn’t just getting more difficult — it’s also becoming much more expensive. 

This is due in part to the fact that data center projects have become significantly larger. But English and other industry experts also point to the skyrocketing cost of bringing power to a site as the major driver of upfront capital needs.

Utilities and grid operators are increasingly concerned that they are spending billions on infrastructure improvements to serve data center projects that may never materialize, thus creating a spike in electricity prices for other consumers.

To mitigate this risk, utilities and state governments in places like Georgia and Ohio are enacting a range of measures requiring data centers to make upfront capital commitments to receive — or in some cases just apply for — power.

In some cases, the required payments for major data center projects can be north of $400M, English said. 

With initial development costs increasing so dramatically and a growing likelihood that developers will have to sit on sites that aren’t producing revenue for extended periods, their need for predevelopment liquidity before securing a tenant is higher than ever. Yet because navigating power acquisition and other predevelopment hurdles has become so complicated and unpredictable, speculative lending has effectively stopped, and a developer looking for liquidity while they secure power and a tenant for a data center site is left with few options. 

“The capital markets have shifted. It’s not as easy for developers to access capital on the front end,” Saavedra said. “It's very difficult to get someone to give you money when you don't have something tangible.”

“So much of the predevelopment process right now for a new site is just lining up the order of operations correctly and making sure you're well capitalized, because the cost can get quite substantial, and it's a delicate balancing act,” Ryan Hughes, managing partner at Sailfish Investors, said at DICE Southeast.

With speculative financing rarely an option, developers’ ability to navigate the predevelopment phase requires them to have liquidity already on their balance sheet. This has been advantageous for data center operating companies that are increasingly backed by major institutional investors and infrastructure funds — investment giants like Blackstone, Brookfield, KKR and Partners Group.

Rather than being real estate transactions, these investments effectively underwrite the operator’s overall growth strategy. Predevelopment risk is mitigated because it is spread across multiple sites and by the operating company’s existing relationships with major tenants. 

“It's not an accident that when you look at the money behind the operating companies, it’s large infrastructure funds often who have a lower cost of capital and long-term time horizon relative to other investors, and they’re raising billions of dollars,” Saavedra said. “You make money in this space by changing the conversation from a cap rate discussion to an EBITDA multiple discussion, meaning that you're selling a platform at exit.”

Not every firm has the balance sheet to bridge the increasingly wide gap as developers look to extend due diligence on land deals to give them time to lock down a tenant.

While speculative lending has all but disappeared, some lenders, like Legacy Investing, are exploring dipping their toes back in, providing liquidity for firms with powered land as they try to line up all the other pieces required to get a tenant to commit to a site, according to Legacy’s English. 

But Saavedra said this remains a limited niche in the market. It is expensive capital for developers and a risky bet for lenders that most players in the industry won’t touch.

“That money is really expensive, and those transactions are few and far between because the risk is too great,” Saavedra said. “Lenders are coming in when they feel comfortable, and typically when you have a financeable event, meaning you have a lease in hand.”