Real Estate Firms Shift Focus From Office, Retail To Digital Infrastructure

With several asset classes facing significant uncertainty, real estate firms are looking at data centers as a permanent fixture in their portfolios.

Retail, hotels and offices have been hit hard by the coronavirus pandemic, and the timeline of recovery may depend on the country’s success in fighting the disease as well as the decisions of countless individual companies on what space to retain. In the meantime, developers and financiers are focused on building out the country’s digital infrastructure. 

“It’s logical that capital is flowing from hotel and retail, and even offices, to multi-tenant data centers,” said Michael Silver, chairman of commercial real estate firm Vestian. “The space is getting crowded with private equity going into it: The money is paying something like 20 times [cash flow] with a 5% cap.” 

Some real estate investment firms with holdings in other asset classes are pivoting to data centers, aiming to capture what may be an extended period of growth in the sector. One such example is American Real Estate Partners, an institutional fund manager traditionally focused on office real estate that is moving more aggressively into data centers. The firm announced last week a $21.5M acquisition of a 10.3-acre site in Ashburn, Virginia, considered the nation’s data center mecca, and said to expect more such deals in the near future. 

Data centers and connectivity deals have become “a significant part of our long term strategy,” AREP CEO Doug Fleit recently told Bisnow in an emailed statement. 

Spencer Myers, vice president of acquisitions at the real estate investment manager Township Capital, said that the firm remains bullish on office and other assets over the long term. But the trends driving demand for data centers aren’t going away, he said. 

“Offices will return in the next cycle. Companies are developing next-generation labs, massive projects with a lot of space between workers, clean rooms and such,” Myers said. “But we’re seeing an acceleration of existing consumer behavior, getting smarter with the consumer. ... The collection of consumer behavior and data takes up space, and that’s where the demand for data centers is coming from.” 

Many developers see data centers as part of an ongoing diversification play that includes not just asset classes but geography and other factors. The shift to data centers is part of a natural market cycle, Charles McCarthy of Suffolk Construction said.

“The pandemic has taxed and tested the digital infrastructure of this country,” said McCarthy, who has managed several large data center builds over the years and now leads Suffolk’s mission-critical group. “Now we’re entering the stage where we’ve gotten through that initial demand, and people are using this time to make adjustments. … That’s where you’re seeing demand.”

For Suffolk, a national construction firm that builds a wide variety of commercial space, including specialized spaces like health care facilities, the data center sector is just one that's expected to expand in the coming years.

"As markets turn, any robust national company is going to have a diverse portfolio,” McCarthy said. “The [data center] market is growing, and at Suffolk, it’s part of a diversification strategy for us.” 

Still, the growth isn’t without risks for the flood of money and resources flowing into the data center space. The industry is moving very quickly, and as technology evolves, the nature of data center demand may change as well. 

Shifts in the industry are already underway, with legacy enterprise data centers already beginning to look outdated in favor of more modern facilities outfitted for interconnectivity across clouds and networks.  

“The providers are turning into real providers. It’s not like, 'Here’s some brick-and-mortar, power and a reasonable environment for taxes,'” Silver said. “It’s becoming an industry of hands-on providers, and these hands are lifting people from enterprise properties, which are legacy, single-use properties, to either a service-driven wholesale local or a retail provider who can take the user from an enterprise system into an interconnected world.”

That presents opportunities as well as potential risks, Silver said.

“If you’re a seller, sell,” he said. “The industry is changing so fast, and the demands are changing, that you have to be cautious about what the replacement costs might be. Today’s facility might be obsolete tomorrow.”