Companies Gobbling Up Turn-Key Data Center Space

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Digital Realty Trust has been the leading beneficiary of active leasing of wholesale data center space in recent months. Here's a look at Digital Realty's Ashburn campus in northern Virginia. (Photo: Rich Miller)

Data center users have leased more than 400,000 square feet of turn-key data center space in recent months, according to a new market survey from real estate firm Avison Young. Despite that strong activity, the market for wholesale data center space continues to face a potential oversupply, the report said, with more than 1.9 million square feet of space available.

Leasing of wholesale space has picked up, with much of the business coming from customers that are new to the wholesale sector, rather than renewals from existing users, according to Jim Kerrigan and David Horowitz of Avison Young. That's a positive trend for the market, suggesting that the growth of the digital economy is prompting more companies to lease "plug-and-play" space rather than build their own data centers.

But the rising tide isn't necessarily floating all boats. "While absorption year to date is significantly stronger than last year, wholesale operators other than Digital Realty Trust did not have a memorable quarter," Horowitz writes in the new report (PDF).

More Players in the Wholesale Space

In the wholesale data center model, a tenant leases a dedicated, fully-built suite of data center space. This approach is quicker and cheaper than building an entire data center facility. The tenant pays a significant premium over typical leases for office space, but is spared the capital investment to construct the data center.

Major players in the wholesale space include publicly-held real estate investment trusts, including Digital Realty (DLR), DuPont Fabros Technology (DFT), CoreSite Realty (COR) and CyrusOne (CONE), along with privately-held companies like Vantage Data Centers, T5 Data Centers, Sentinel Data Centers, Compass Datacenters, Ascent Corp., Fortune Data Centers, Sabey Data Centers, Corporate Office Properties Trust (COPT) and QTS (Quality Technology Services).

Digital Realty leased 6 megawatts of space in Northern Virginia and another 3 megawatts in Chicago, according to Avison Young. The company reported leasing 248,000 square feet of turn-key space in the fourth quarter of 2012, compared to 22,000 square feet for CoreSite and 5,500 square feet for DuPont Fabros (which also signed new leases for 74,000 square feet). First quarter results have will be released over the next several weeks.

Focus on Supply, But Market Dynamics Change Quickly

In recent years analysts and industry watchers have been focused on the supply of wholesale data center space, worried that the entry of new players would lead to an oversupply of available space. The surge in construction of new wholesale space has been supported by investors seeking to capitalize on the strong performance of leading players in the data center industry.

An abundance of supply can impact leasing rates, as providers in crowded markets may begin to compete on price. Thus far, most of the pricing impact has been confined to the largest and most competitive regions, including Silicon Valley, northern Virginia and New Jersey.

But Avison Young believes the supply worries will be resolved in 2013.  "Despite current low wholesale pricing, expect an uptick in pricing in most markets," Horowitz wrote. "The better Tier III wholesale options will disappear as the year moves on."

Kerrigan says that there are a number of large requirements in the pipeline that could fill large chunks of wholesale space, quickly altering the supply vs. demand equation in key markets. He said supply in large markets has historically fluctuated between periods of limited supply and periods of abundant space. Because of the capital-intensive nature of data center construction, wholesale providers have historically waited for existing supply to be absorbed before commencing large new construction projects. This wariness is also a byproduct of the early 2000s, when speculative building led to bankruptcies and oversupply.