Storage Wars: Web Growth Sparks Data-Center Boom
By ANTON TROIANOVSKI
Wall Street Journal
JULY 7, 2011
For years, as Internet use boomed, builders of the giant, air-conditioned computer warehouses known as data centers couldn't keep up with demand.
Now, though many investors continue to pile into the data-center business, one of the few hot spots in real estate, others fear the peak may be past.
In key markets from New Jersey to Silicon Valley, there are signs that supply is catching up with the needs of the telecommunications, Internet and other companies that rent space from data-center landlords. Adding to the concern, some large tenants, such as Facebook Inc., are building their own facilities and avoiding paying rent to outside developers.
In the San Francisco Bay Area, rates charged to big tenants who rent entire data centers or large parts of them have fallen some 20% in the past year and a half, amid a burst of new supply, says Tom Ray, chief executive of CoreSite Realty Corp., a data-center landlord with facilities in the area.
Other market participants say they haven't seen a steep decline in Bay Area rates, but some are nervous about a new wave of construction expected to hit the market later this year.
"A lot of people are going to get burned, because they've got caught in euphoria," says Manny Medina, a longtime data-center investor who in April sold his company, Terremark Worldwide Inc., to Verizon Communications Inc. for $1.4 billion. "Eventually, there's going to be a reckoning."
Data centers, which house and link the servers and other gear that form the backbone of the Internet, have become a big business. Revenue for providers in North America will reach $8.1 billion this year, up from $5.7 billion in 2009, according to Tier1 Research, which tracks the industry.
Terremark now has nearly 50 data centers. Kerry Bailey, who runs Terremark for Verizon, says the telecom giant's ability to integrate new facilities into its global network sets its services apart in an increasingly crowded field. "We believe the market is moving in our direction," Mr. Bailey said.
Many data-center developers, who often break ground before signing up tenants, are continuing to steam full-speed ahead. Their theory: with Internet traffic exploding—Cisco Systems Inc. expects it to quadruple over the next five years— and more companies outsourcing their data storage, demand for the space can't help but increase.
In Silicon Valley and the New York metropolitan area, the supply of data-center space rose by just 3% in 2009 but is expected to grow by nearly 10% this year as real-estate financing opens up, according to Tier1.
Digital Realty Trust Inc., a major data-center developer, had more than 1 million square feet under construction in 11 markets from Boston to Singapore as of March 31, at a cost it estimated at $321 million. Another developer, DuPont Fabros Technology Inc., had three massive projects under way in California, Virginia and Illinois at a cost of around $550 million.
Vantage Data Centers, owned by private-equity firm Silver Lake Partners, is building a 314,000 square-foot, $300 million complex in Silicon Valley and planning to expand to other parts of the country.
"The amount of capital going into data-center construction is remarkable," says Stephen M. Smith, CEO of data-center operator Equinix Inc. This year alone, Equinix, which runs 98 data centers, has set plans to build or open new facilities in Amsterdam, Paris, Dallas, New York and near São Paulo, Brazil.
Equinix plans to spend $615 million to $665 million in 2011 on capital projects, primarily data-center expansion. But even Mr. Smith says overbuilding in the industry "is a main concern."
In New Jersey, major data-center space—properties 100,000 square feet or larger—has roughly doubled since 2005, according to commercial-real-estate firm CB Richard Ellis Group Inc. That helped push the vacancy rate in the northern part of the state to what KeyBanc Capital Markets estimates was 14% in April, up from 12% in December. In the Bay Area, CoreSite expects new supply to outpace demand by as much as 50% in the second half of the year.
One reason for the imbalance: Facebook, a huge user of data centers, has been building its own sprawling server farms, joining other tech giants that already operate their own facilities. Google Inc. has been building its own data centers for years, while Apple Inc. unveiled a new data center in North Carolina last month.
"It used to be a no-brainer: You build it, and if it's well built and well located, Facebook would lease it," says Sutton Roley, a Silicon Valley data-center broker with brokerage firm Cassidy Turley. "That's no longer the case."
Some who had predicted trouble in the industry in recent months say demand is holding up better than they had expected. Ross Nussbaum, an analyst who follows real-estate stocks for UBS AG, published a research note in December warning data-center developers were trading at "unsustainably high valuations" despite slowing growth, rising competition and pricing pressure.
Yet so far this year, shares of the largest data-center real-estate investment trust, Digital Realty, are up 24%, outpacing the 11% gain in a Dow Jones index of real-estate stocks.
"The market has chosen to look past the increased level of supply that has entered some markets," Mr. Nussbaum says. He says he still believes Digital Realty's valuation is unsustainable.
A Digital Realty spokeswoman said supply and demand are "pretty much in balance" in two of the company's key markets—Santa Clara, Calif., and New Jersey—but it still sees opportunity in other markets, such as Boston, and overseas.
—Spencer E. Ante contributed to this article.
Write to Anton Troianovski at anton.troianovski@wsj.com
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