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A Paradigm Shift for Data Center Ownership

| February 23, 2015 | 0 Comments

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Cushman & Wakefield of New Jersey, Inc.
One Meadowlands Plaza, Suite 1100
East Rutherford, New Jersey 07073

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Release Date: Monday, February 23, 2015

Media Contact: Evelyn Weiss Francisco (201) 796-7788

New Breed of Specialized Investor Makes Selling a Smart Consideration

By Sean Brady, Senior Director

Cushman & Wakefield

East Rutherford. N.J.

EAST RUTHERFORD, N.J., Feb. 23, 2015 – To own or not to own a data center. If your organization owns its own data center or the building that houses it, now is the time to consider selling. A new breed of specialized investor, one well versed in data center operational needs, is becoming increasingly active in acquiring corporate data centers (several of these players now own dozens of these properties) and leasing them back to the selling entity. They are paying top dollar, while at the same time the seller retains all the flexibilities they appreciated while owning the site.

Why is this a good time to sell? The market today contains plenty of pent-up real estate capital. Investors are anxious to invest in data centers, especially in the New York Metro area. We are seeing lower cap rates for this niche – which has proven to be one of the most stable in the entire real estate sector.

At the same time, many corporate data centers have been in operation for almost 20 years. These assets are becoming antiquated. It does not make sense as an owner/operator to wait and sell a data center building at the end of its useful life, when its infrastructure has little remaining value. Additionally, owners/operators of these buildings typically do not upgrade the outside appearance because they do not want to draw attention to the building or risk interrupting its day-to-day operation by knocking out the power or fiber. As such, at the end of a 15- to 20-year occupancy, it may cost more money to return the building back to Class A or B+ office building than what can be gained by selling it at the end of this period.

THE UPSIDE TO SELLING

For these reasons, corporate data center owners should strongly consider the merits of selling while the time is right. There is no downside to this exercise. The national investors active in the market today understand the data center industry as well as the nuances of data center ownership. They structure specialized leases that give the corporate data center seller maximum flexibility to perform their day-to-day operation as well as necessary construction projects. Improvements like installing new fuel tanks, a chiller plant, UPS and/or generator, or reinforcing the floor to accommodate heavier loads are easily approved provided that the occupant secures all the permits, stays within code and does not allow any liens on the property. And, in most cases, the buyer/lessor will not have the lessee restore the building at the end of the lease.

Further, these buyers are paying between 6 and 9 percent cap rates, depending on the quality of the tenant's credit and the quality of the asset. Three sale structures have become common.

  • Option 1 is a net lease on the real estate in the range of $10 to $30 per square foot, NNN.
  • Option 2 is a net lease on the real estate and the data center equipment, which might create a rent of $50 to $100 per square foot and a sale price of $300 to $400 per square foot.
  • Option 3 is a net lease on the real estate and equipment plus the buyer will provide the seller capital upfront to upgrade the building or the data center (investing $30 to $60 per square foot in construction allowance, divided by the 10-year term plus interest provides the new net rental rate, and the per square foot price could be higher than the numbers above).

The higher the rental rate the seller agrees to, the higher the sale price and potentially the lower the cap rate. The second and third options are available only through a few investors who put a value on the equipment and provide the seller with the Cap X to update the asset. They are great vehicles for using someone else's money to upgrade the real estate and/or the data center.

A PARADIGM SHIFT

Over the past four decades, most large corporations have chosen to own their data centers because they want to have total control of their mission-critical facilities. The corporate data center operates 24/7/365 and stores some of a corporation's most important asset: its information (trade secrets, patents, client information, etc.). Corporations also like to own their own data center buildings because they invest a lot of money into them and can write down a good portion of it. This sound thinking for many years was augmented by the fact that landlords did not provide the flexibility data center operators need. Simply put, it was better to own than lease.

During the past several years, however, data center-specific investors have come into the market and created a paradigm shift that is quickly gaining momentum. Most importantly, they offer extraordinary flexibility. Additionally, the rapid evolution of data center design, efficiencies, size, capacity and layout means that 10 or 20 years from now, even today's most modern data center facility will be obsolete. We have seen more technological advancements in the data center industry during the past five years than we have in the past 20 years. By leasing, corporations transition the financial burden – easily reaching millions of dollars – to update/restore the building to bring it current. Further, history has shown that the "ideal" location for a company's data center can change. Previously, remote locations were favored. Today, most companies are trying to keep the data centers within one hour of the headquarters or regional headquarters to accommodate their professional IT staff. Leasing enables companies to move with the times, as needed.

WHAT INVESTORS WANT
Currently, available capital for corporate data center purchases exceeds the availability of assets[MB1] , which, combined with low interest rates, is bringing a lot of attention to this "new" asset class. Most often, corporate data center investors are looking for buildings that are at least 50 percent dedicated to a mission-critical operation like data center, disaster recovery, call center or business continuity space. They are seeking good credit tenants, long-term leases, and typically a building that is predominantly controlled by one tenant. These buyers appreciate properties that have been well maintained, however it is not uncommon for them to provide the seller with capital to renovate the building commensurate with a long-term lease. For corporations with data center properties that fit this profile, testing the water now is worthwhile – and will undoubtedly bring great interest.

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Cushman & Wakefield's Sean Brady is a Senior Director and Co-Founder of the firm's Global Data Center Advisory Group, which includes the real estate industry's most experienced advisors within this highly specialized asset class. Focusing on Greenfield, Industrial Conversions, Wholesale, Co-Location, Managed Services, Cloud, and Corporate Data Centers and Disaster Recovery Sites, the group includes 30 brokers, business continuity and crisis management, incentives and location consulting, cost segregation, appraisers, project and facility managers, and currently manages more than 20 million square feet of mission critical space.

For most organizations, real estate represents the largest expense on the balance sheet. Overseeing this real estate requires multiple expertise, across multiple geographies. From Tenant Representation to Project Management to Facilities Management to Sustainability Services – Cushman & Wakefield's expertise will be delivered seamlessly and reduce your costs, mitigate your risks, and enhance the efficiencies of your real estate. Most importantly, we will provide you with the right occupancy solution to fit your complex needs.

Cushman & Wakefield advises and represents clients on all aspects of property occupancy and investment. Founded in 1917, it has 248 offices in 58 countries, employing more than 16,000 professionals. It offers a complete range of services to its occupier and investor clients for all property types, including leasing, sales and acquisitions, equity, debt and structured finance, corporate finance and investment banking, appraisal, consulting, corporate services, and property, facilities, project and risk management. To learn more, click HERE.

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