Data Center Sales Are Up, But Most Investors Are Staying On The Sidelines

Data center sales are up after two lean quarters, but experts don’t expect a return to record volume anytime soon.

Last week, Japanese telecom provider KDDI acquired three Toronto data centers from Allied Properties REIT in a deal valued at $1.2B. It was the largest deal so far in the second quarter, which has seen an uptick in trades of North American data center assets after six months of sales scarcity triggered by rising interest rates.

Data center market experts attribute this higher deal volume in part to both growing comfort with shifting valuations and sellers motivated to unload assets in order to fund new development, but they are quick to temper any expectation that these modest gains are the start of investment activity returning to the record levels the industry saw just a year ago. 

“It's not flipping a light switch, where now things are back to early 2022 or 2021 levels” said Karlton Holston, executive vice president for digital infrastructure at Landmark Dividend. “Interest rates are somewhat stabilized now, which is having an impact, and people are getting comfortable with what pricing is today.”

Sales of data center assets all but ground to a halt in late 2022 and through the first quarter of this year.

According to data provided by CBRE, there were just two data center transaction in North America in the final three months of 2022: the sale of a vacant facility near Dallas and CloudHQ’s purchase of a former UnitedHealth data center in Minnesota for $90M. The two deals totaled just $138M.

The first quarter of 2023 also saw just two deals, with Blackstone acquiring a stake in five Virginia data centers through a JV with COPT and Starwood selling a single facility in Loudoun County to GI Partners. 

As Bisnow previously reported, the sudden decline in sales volume was triggered largely by a lack of clarity on interest rates that prevented owners from putting properties on the market. 

Higher interest rates and accompanying debt market volatility have led to lower valuations for data centers, with buyers seeking reduced acquisition costs to maintain margins as it becomes more expensive to borrow. Data center owners who may have been looking to unload parts of their portfolios have slammed on the brakes as cap rates climb and potential returns diminish.

This volatility made deals difficult to successfully execute. Not only were buyers and sellers finding it more difficult to agree on the value of assets, but the fundamental math underpinning negotiations could shift significantly with the cost of capital over the course of a negotiation. 

But while interest rates remain high and further hikes remain a possibility, the number of data center transactions has also crept upward over the past three months.

There have been five data center transactions in North America this quarter in deals valued at $2.42B, according to CBRE — more trades than occurred in the preceding six months. This includes large portfolio sales like KDDI’s Toronto acquisitions and GI Partners $700M purchase of two Chicago-area data centers from Digital Realty. 

Why has there been an increase in sales volume even as interest rates remain high?

Part of the equation, experts say, is that buyers and sellers now have more clarity when it comes to valuations that were in flux a few months ago. Meanwhile, some sellers have adjusted their expectations to the reality that their assets won’t fetch the kind of prices they may have at this time last year. 

“Sellers had a hard time wrapping their heads around decreased valuations,” Landmark Dividend’s Holston said. “It’s tough to make the adjustment that they had to earlier this year and get comfortable with where things stood from a few months earlier after such a huge uplift in interest rates.” 

Also driving the bump in deal volume, experts say, is the fact that some of the world’s largest data center owners are hoping to fund new development by selling off existing assets.

Data center giant Digital Realty, faced with a declining stock price and rising debt load, is the most prominent firm to embrace so-called capital recycling to fund growth. Indeed, the strategy has yielded some of the quarter's largest transactions as the REIT sold a pair of Illinois data centers to GI Partners for $700M and sold a Houston data center to the building’s tenant, Databank, for $151M. 

“They were really just bringing up cash, and they needed to do it,” Andy Cvengros, a managing director on JLL’s data centers team, said of Digital Realty. “They were capital-constrained and they needed to free up capital — they [had] not been active in the marketplace in terms of acquiring new land, building on spec and things like that.”  

While data center sales are up, industry insiders who spoke with Bisnow were quick to paint the increase as modest — far short of a wave of deals similar to what the industry saw over the preceding two years. 

“There’s been a warming, an adjustment of seller expectations … but this is not a huge number,” said CBRE Vice Chairman Rob Faktorow, who co-founded the firm’s data center advisory practice. “You’re talking about a nine-month period with a total of nine transactions. There’s just not a lot of volume in the space.”

Few expect a wave of this kind of investment activity in the near-term future. Expected returns on core data center assets, many of them with credit-grade tenants signed to long-term leases, are small, meaning that the higher cost of capital has a significant impact on margins. Landmark Dividend’s Holston said that as long as the cost of capital remains high, most investors will continue to sit things out for all but the largest deals. 

“I don’t think anyone’s fully jumping back in,” Holston said. “Everybody’s still really on the sidelines unless you’re taking on one of these large portfolio deals.”

A data center sales surge might not be imminent, but some experts say there are other factors that make a significant wave of data center transactions likely in the near-term future. Specifically, experts point to the wave of data center development that has occurred over the past five years, much of it underwritten by private equity firms and other investors who will want to exit those development deals in the months ahead. 

“I think we’ll see more over time,” Faktorow said. “Developers and investors typically want to own assets for five to seven years — the growth of the business over the last five to seven years is enormous, so it's only now going forward that we'll start to see a lot larger volume.”