The Year in Review: Data Centers

December 14, 2020

CPE invited JLL industry experts Andy Cvengros and David Barnett to analyze the sector's performance in 2020.

(Left to right) Andy Cvengros, David Barnett, JLL. Image courtesy of JLL

The data center sector has proven resilient in the face of the COVID-19 crisis, ending 2020 strong while concocting strategies to boost the economy in the year ahead. The latest JLL data center outlook highlights its steady position, as data center REITs outperformed other sectors in total returns, driven by increased demand for e-commerce and virtual connectivity.

Commercial Property Executive provides a snapshot of the sector’s performance throughout 2020 through the eyes of JLL Senior Vice President Andy Cvengros and Research Manager David Barnett. The experts touch on past and current opportunities and challenges within the sector, explaining how this year’s changes paved the way for forward-looking strategies.

According to the Nareit U.S. Real Estate Index Series, data centers recorded the highest year-to-date returns in the first quarter of 2020 due to immediate demand for digital connectivity. How does the sector brace for increased demand?

Barnett: In the immediate term, REITs will focus on executing deals in the pipeline. We have seen record amounts of backlogs among REITs this year. They also need to maintain their high levels of service amid increased demand. Third, they will have to navigate delays in the construction pipeline.

Cvengros: A good deal of large data center providers develop campus-like projects where they furnish many of the major, long lead components such as fiber, power and a building shell on a speculative basis. This allows the provider to build out a tenant’s infrastructure on an as-needed basis in just 90-to-120 days.

What are the challenges operators and users face despite an immediate need for capacity?

Barnett: Data center operators were able to keep critical staff as they were considered essential services amid the pandemic. While there were disruptions and delays in the construction pipeline, operators have been mostly unscathed by the pandemic relatively compared to other sectors.

Cvengros: Reducing operational costs will be crucial with increased demand, whether it is energy costs, cooling or labor. For large deployments that require new development of raw land, we have seen delays in obtaining proper approvals, which may include zoning changes and variances due to local government shutdowns.

In what way have these challenges shaped the sector’s direction throughout the year?

Cvengros: This has caused operators to think outside of the box as they develop data center space. Many providers are rushing to develop new properties, buy existing buildings or data centers and speculatively build greater amounts of critical infrastructure in advance of tenant demand.

The pandemic has accelerated competition among operators. How can they stay competitive, get ahead on cost and attract large users?

Cvengros: Competition has indeed increased among operators, especially in the U.S. Innovations in construction have helped to bring down capital expenditure, which is significant in the sector compared to others. Sustainability goals are in place, which both drive great recognition in the industry but provide real cost savings as well. Operators are working smarter by using operational automation or artificial intelligence in facility management to streamline sustainability, monitoring and quality control.

Operators are entertaining different services including fiber connectivity and flexible contracts. They are choosing strategic sites that allow for a high availability and access to fiber connectivity and cloud carriers.

Barnett: Operators have increased their focus on international markets where they can get better returns. Most markets in the U.S. have seen rent compression, therefore some markets in Europe and the Asia Pacific region are a bit more attractive. We have seen this reflected in mergers and acquisitions, notably Digital Realty’s expansion in EMEA.

How does this competition reflect on smaller digital infrastructure providers?

Cvengros: It makes it increasingly more difficult to compete due to the vast amount of money needed to develop a large-scale data center. Smaller providers and smaller facilities are not as efficient as those built at a much larger scale.

How has IT infrastructure changed throughout 2020?

Cvengros: Infrastructure is getting smaller while requiring higher-power density. Users are virtualizing and consolidating their gear to be cloud-ready. This new infrastructure runs at 7-10 kilowatts per cabinet whereas legacy cabinets are 2-5 kilowatts per cabinet. A portion of a typical company’s infrastructure is now moving to cloud-making for much smaller requirements from the enterprise companies.

How have connectivity strategies changed since the onset of the pandemic?

Barnett: The pandemic has not necessarily changed strategies but has accelerated certain ones and shifted priorities. Low latency needs, especially for online learning and increased remote work, will continue to rely on edge deployments to get closer to the end users.

Cvengros: Telecom providers are working to accommodate substantial growth through the expansion of their pop sites.

One of the trends that accelerated in 2020 was user migration to the public cloud. What can you tell us about this tendency?

Barnett: On the user side, the pandemic has served as a stress test on cloud capabilities for organizations. Organizations that were spending more and allocating resources on internal hosting and service lacked the ability to easily flex and scale up and down to reflect COVID-19 pressures on costs.

Outsourcing data hosting can lower the total ownership cost across the data center requirement and improve flexibility, albeit maybe at the expense of proprietary security. This is not necessarily new but is an accelerating trend amid the pandemic.

Elaborate on the factors driving an increase in revenue for public cloud services.

Barnett: Software-as-a-service remains the largest component of public cloud revenue. Public migration has been occurring for years, but we have seen it accelerated as of late.

Cvengros: This cloud service allows organizations to scale their needs appropriately, proactively and on-demand, which has been of utmost importance in a pandemic where remote work has taken over.

Domestic demand was strong in the first half of the year, with eight of the 14 markets in the U.S. recording an increase in net absorption. Talk about the most significant market shifts you witnessed year-to-date.

Barnett: Operators have homed in on Salt Lake City for its diverse fiber routes and connectivity in the Southwest and Pacific West regions. There has been robust expansion in the market given its favorable geography and location and low power rates. Another box checked off the list is the state’s recent data center tax exemption program. All these attributes will likely lead to continued investment.