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Financing Strategies for Data Center Operations: A Comprehensive Guide
Explore financing strategies tailored to data center operations, from traditional loans to emerging options like yieldcos.
7 Min Read
Data center financing strategies are evolving to meet growing demands, from traditional loans to innovative approaches like yieldcosImage: Alamy
Financing data center operations calls for careful planning to manage ongoing costs, capture growth opportunities, and sustain operational resilience.
This guide outlines key financing solutions for data centers – from traditional loans and private equity to emerging instruments like yieldcos.
With a strategic approach, data center operators can optimize funding structures to maintain steady cash flows and drive expansion. In this guide we'll cover:
Financing for Data Center Operations
When an off-premises data center is up and running, the operational income is used to offset the daily expenditures and provide returns for the initial investment. This is often described as part of the equation for the total cost of ownership (TCO).
While the business models vary — either in the form of hyperscalers providing "all-in" cloud services or colocation providers renting out space — data centers are like any other commercial asset having a dynamic financial outlook.
Apart from the revenues arising from rental and service contracts, day-to-day operational expenses of data centers may be met by accumulated earnings, shareholders’ capital, real estate or corporate loans, holding company loans, or equipment leasing.
In the unfortunate scenario of financial distress, a US operator may try to obtain debt-in-possession financing from banks as a last resort to alleviate the pain of a bankruptcy process when filed under Chapter 11 of the US Bankruptcy Code with a view to possible emergence.
Data center financing options include REITs, private equity, and sale-and-lease-back agreements to support growth (Image: Alamy)
Data centers can normally maintain a healthy cash flow unless the operating environment is hindered by factors such as high interest rates from borrowing or the spillover effects of a worsening economy, causing tenants to default in rental payment.
The regionally diverse and often multinational locations of data centers owned by a major operator present a diversified risk portfolio to investors. In the capital market, the regular income streams of data centers can be securitized into asset-backed financial products called real estate investment trusts (REITs), which provide an investment alternative for investors taking advantage of the risk-balanced income generating portfolios, thereby enabling interest to be distributed amongst them.
As a capital market instrument, REITs are traded in the same way as stocks with potential for upside or downside market price movements. Like stocks, a REIT’s prices may be adversely affected when its distribution per unit falls from, say, defaulted rental payments from even one major tenant.
The proceeds arising from the initial launch of REITs may be used for the refinancing of loans taken by the operator or for expansion and growth.
Financing for Data Center Asset Transactions
As a means of quick market access or expansion — or simply as an attractive investment — in the wake of the growing digital economy, data centers have become a ‘hotspot’ asset class undergoing a burgeoning trend of mergers and acquisitions (M&A).
Unlike new construction progress payments, which can be spread over the duration of the development process, M&A transactions need to be funded upfront initially, with a possibility to reinvest when up-scaling or upgrading becomes necessary.
While debt and equity are predominantly used as in new construction, acquisitive investment in an existing data center tends to be equity-based for buyers to retain control of the asset and enjoy the upward earning potential.
Sale-and-lease-back deals offer a flexible data center financing option, unlocking capital while maintaining operational access for owners (Image: Alamy)
More recently, infrastructure funds have been actively acquiring well-run data centers using their private equity clout. This year, a notable transaction took place in the open capital market. A KKR-led consortium, on behalf of its managed funds and Singtel, acquired redeemable preference stocks issued by ST Telemedia Global Data Centres (STT GDC), an established operator with a portfolio of more than 95 data centers globally. The transaction also included a bundle of detachable warrants.
A warrant is a derivative instrument with a right, but not an obligation, for holders to buy or sell an issued stock before a specified future expiration date at a stated price — possibly to cater for future re-investment needs. When fully exercised, the deal is worth $1.75 billion. After the transaction, ST Telemedia, the parent company of STT GDC, continues to be the majority shareholder of the latter. One caveat to note is that upon warrants being exercised by the holder, or converted into ordinary stock, the stock holdings will be diluted for all stockholders.
Another case in 2024 involved the selling of $587 million of convertible preferred stock by GDS International, a Southeast Asian data center operator, to private institutional investors. Convertible preference stock carries fixed dividend rates, and in this case may be converted into ordinary shares by the holders at any time or automatically upon/following the IPO of GDS International. Assuming full conversion after closing of the deal, it was reported that private institutional investors will own 43.9% of GDS International’s stock.
Sale-and-Lease-Back Financing Options
Given a favorable low-interest environment, sale-and-lease-back could be an attractive option for existing owners who may find their own operation more costly than selling and leasing back from a colocation group.
This may be due to corporations owning legacy data centers that may not be fully utilized for their own use or being run at low energy efficiency. Hence, it makes sense to sell to a specialized operator who may be able to perform better, and yet wants an anchor tenant before renting to others.
The original owner, however, may lose some control of the facility — including security of its own IT operations. The attractiveness of this type of deal is very much affected by the cost of borrowing capital available to potential buyers and the capitalization rate they can achieve.
Read more of the latest data center investment news
Yieldcos Emerge as a New Financing Option
Inspired by the renewable energy development sector, mature data centers are regarded as stabilized assets capable of generating regular cash flows to provide a reasonable return and prospects of dividend growth.
Yieldcos are endowed with such assets by their parent companies to enjoy a low cost of capital by attracting stockholders’ investment seeking stable and predictable returns.
In a way, this is a capital recycling approach for new project development given a low-interest environment and a suitable tax regime. Data center operators with multiple project portfolios have started to look into this new financial engineering approach with due care and hence gradual steps are being taken to forge ahead.
Financing Caveat Amid the Data Center Investment Boom
In line with the fast development of AI applications — particularly for the training of systems — new data centers are being built with higher energy efficiency and rack densities, necessitating the deployment of liquid cooling and other capital-intensive technology.
M&A activity is ramping up on existing data centers for market access, expansion and investment reasons. As such, the demand for financing is strong.
Against this backdrop, however, it would be prudent to look at recent market developments — such as the increased movement towards edge computing and the low latency requirements for the inference side of AI — which imply less intensive but more geographically diverse locations for data processing, as well as the resilience of on-premises data centers among corporations.
Note: This article is for informational purposes only and should not be considered financial advice. Always consult with a financial advisor to ensure any data center investment decisions align with your organization's financial situation and objectives.
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