Silicon Valley’s Data Center Market Starting To Lose Its Luster

Historically, Silicon Valley’s data center market has been robust, but the price of doing business in California could quickly quell tenant demand.

Analysts have concerns about the sector’s ability to grow as utility giant Pacific Gas & Electric continues to hike energy prices, construction costs keep rising and California’s permitting process becomes increasingly onerous.

“While San Jose remains an important data center market, it's kind of losing its luster,” said David Guarino, a data center and tower analyst at real estate analytics firm Green Street. 

“It's really hard to get things done in California in general, and with the challenges from utility providers with the bankruptcies and after all the wildfires, it’s been difficult to get power to these sites,” Guarino said.

Tenants’ servers are consuming more power than ever, processing large amounts of data for an array of companies that rely on big data from artificial intelligence startups to tech stalwarts like Google. 

Although many Silicon Valley companies consume a vast amount of power, they are increasingly searching for cheaper solutions when it comes to building new data centers, including alternative energy sources.

“A lot of folks are not putting big data centers up in California in general. They've shifted towards Phoenix, which is capturing the vast majority of internet traffic, particularly for NorCal,” Guarino said. “The other emerging market people are talking about is Reno, which is really starting to get some traction now.”

Guarino also pointed to Hillsboro, Oregon, as an emerging data center market. 

Challenges permitting projects add fuel to the fire for many tenants.

Private equity company GI Partners encountered challenges from the city of Santa Clara when it applied to rezone an office property at 2805 Bowers Ave. to redevelop it as a four-story, 72-megawatt data center, Cushman & Wakefield reported. The proposal didn't receive the votes required for approval. GI Partners will have the opportunity to appeal the ruling. 

When searching for a data center, companies are primarily driven by “power, power, power,” Cushman & Wakefield Executive Director of Global Data Center Advisory Ali Greenwood said. Tenants prefer to set up shop within the boundaries of Silicon Valley Power, a utility company owned by the city of Santa Clara, instead of areas serviced by the privately owned PG&E, she said.

In the first half of 2024, Silicon Valley’s colocation vacancy rate of 4.7% was slightly better than average, with an absorption rate of 20.5 MW, according to a new first-half global data center report by Cushman & Wakefield. Colocated data centers are those with more than one tenant.

The brokerage firm reported that Silicon Valley’s data center market is expanding, including among hyperscalers, which are large cloud services companies occupying a data center as the sole tenant.

AWS hopes to strike a 20-MW power purchase agreement with Bloom Energy for fuel cells in Silicon Valley.

“In this case, the hyperscaler is covering costs for local utility operations at the generation site, an arrangement that is growing in frequency across multiple markets as utilities seek to keep up with power requests,” according to the Cushman & Wakefield report. 

Data center REIT Equinix delivered the initial phase of its first xScale data center, offering an estimated 24 MW of capacity for hyperscale uses.

Dallas-based Prime Data Centers has also set its sights on Silicon Valley, with one 80K SF property completed in Santa Clara and another 406K SF under construction or in the planning stages.

For hyperscale data centers, the tenant pays rent and utility costs.

As for a colocation center, Equinix’s Great Oaks campus in San Jose is a prime example, Guarino said. Occupants of these facilities structure their leases much like a full-service gross lease, except the rent and energy expenses are bundled together.

The REIT might set a monthly lease rate of $20K per month, with a third earmarked for energy costs. But if the tenant consumes less than $6,600 worth of power in a month, it still pays for the unused power and the landlord pockets the rest. 

The data center leasing market mirrors the office leasing market in one sense: It remains bifurcated. Newly developed centers featuring the latest technology and Class-A build-outs are performing much better than their older counterparts.

“It’s a flight to quality for many Silicon Valley tenants,” Greenwood said. “New, Class-A leasable space is 95% preleased.”

Meanwhile, older, outdated data centers without the power capacity needed to compete in today’s AI-driven market will continue to face challenges.