Empty Silicon Valley Offices Look Like Opportunity For Data Center Developers

Data center developers are increasingly eying vacant Silicon Valley office buildings as brownfield development opportunities in the world’s tightest data center market.

At the center of the tech universe, Silicon Valley remains one of the world’s most important digital infrastructure hubs and the second-largest data center market behind Northern Virginia. But even as demand for data center space far exceeds supply, it also remains one of the toughest markets to build new facilities. Developers are stymied by high costs, little available land and power, and notoriously long wait times for permits and power connections.

Now, data center builders are seeing opportunity in the decline of the Bay Area’s office market. As tech companies and other area businesses ditch corporate headquarters and downsize office footprints, developers are looking at some of these properties for brownfield data center builds or even conversions.

Industry insiders speaking at Bisnow’s DICE West event, held Nov. 30 at the San Jose Marriott, said some of these properties present unique opportunities to make data center projects pencil in what may be the industry’s most challenging market.

“I think brownfields going forward will be an increasingly bigger part of how data center providers, third-party providers in particular, develop and deploy capacity,” said Peter Hopper, managing director at digital infrastructure fund DigitalBridge. 

Data center developers are hoping to take advantage of a Silicon Valley office market that has been among the hardest hit from the pandemic-prompted trend toward remote work. The Bay Area as a whole has been among the slowest U.S. markets to bounce back since cases of Covid-19 began to decrease and companies nationally began calling workers back on-site.

Vacancy rates in Silicon Valley continued to rise in the third quarter, climbing from 22.5% to 23.1%, while leasing activity and rents both continued to decline, according to Avison Young. Data from Kastle Systems shows San Jose and San Francisco have two of the lowest return-to-office rates of the 10 markets it covers.

The result, experts say, is that companies are trying to shed their large and underutilized office footprints, presenting an opportunity to acquire properties at valuations that are a fraction of what they would have been just a few years ago.

“In this specific market, what you're seeing is legacy headquarters that are being given up," Layer 9 Datacenters CEO Michael Ortiz said. “They're moving and now distributing those offices, where instead of putting 100K SF at one footprint, it's maybe three 25K SF footprints spread across San Jose, Milpitas and San Francisco.”

While offices sit empty, demand for data centers in Silicon Valley is significantly outpacing supply. In fact, Silicon Valley’s data center vacancy rate is the lowest in the U.S., hitting an all-time low of 1.3% in the first half of the year, according to CBRE.

This supply-and-demand imbalance persists because it is enormously difficult to build data centers in the capital of big tech. Developable land and power aren’t just expensive, they’re increasingly scarce, with greenfield plots appropriate for data centers all but nonexistent. Perhaps more importantly, in an industry where speed to market and the ability to deliver a project quickly is everything, the Bay Area is infamous for the unusually slow processes for connections to power and permitting.

“Finding property is a challenge because almost all the low hanging fruit has been utilized at this point, but the biggest obstacle that we are seeing is getting the permits,” Microsoft partner Anuraj Jhajj said. “If you have to build a data center, a greenfield, that requires its own substation, you can forget about starting construction for the next five years — the permitting alone is going to take five to six years just on that substation part.”

This slow speed-to-market issue makes office buildings that are being vacated an especially intriguing play for the data center sector, experts said at DICE West.

It is not that building on these sites will make the process any faster. Rather, experts say that because these buildings are still generating revenue, they allow developers to make a more appealing pitch to investors who would otherwise be scared off by a data center project that won’t see any return for the better part of a decade. 

Brownfield developments on office sites helps address what has been one of the unique challenges of financing data center projects in Silicon Valley, Layer 9’s Ortiz said. Investors simply don’t want to wait more than five years to get any sort of return, especially when projects in other markets would be fully leased and occupied in a fraction of that time.

But an office site still largely occupied by a company that is in the process of transitioning to a smaller office footprint generates revenue that can be paid back to investors as dividends while the developers proceed through the lengthy permitting and power connection process. Ortiz said it is a strategy that is helping draw investment. 

“That private equity money is not going to sit there and go: 'You know what, don't worry about it, don't pay us a dividend.' No, they want that money to go to work immediately,” Ortiz said. “You need to start looking at assets that you can generate income while you're driving your project, and then when these people do move out, you have a project where you can turn it into a facility that's generating higher returns.”

Experts pointed to a series of teardown redevelopments and even conversions of office properties across Silicon Valley in recent months. Hong Kong-based RiCloud in October completed a $100M conversion of an 80K SF San Jose office building into a colocation data center, while CoreSite’s recent expansion of its Santa Clara campus repurposed the site of a low-rise commercial building called the Stender Business Center. Vantage Data Centers has also dramatically expanded its presence in Santa Clara through brownfield developments on office and research sites.

But these projects do carry risks, DICE West panelists said. It is unusual to find office properties that are already connected to the kind of power data centers need, and it can be difficult to work with the utilities in the region to build that connection.

In some cases, Silicon Valley utilities have withdrawn existing power commitments on brownfield sites because they went unused for a matter of months. There’s also a risk that comes from banking on the existing tenant actually vacating an office property when it says it will. But experts said that in a market at tight as Silicon Valley, these kinds of risks and creative strategies are what is required to move projects forward. 

“When you buy a legacy asset, you may have tenants that say they're going to move out at the end of the year, but do they really move out? That can become an issue, along with the unknowns that you always deal with on conversions,” said Aaron Wangenheim, chief operating officer of T5 Data Centers. “But in this kind of market we need to think outside the box, and we need to take certain risks.”