ByteDance, Edge Markets, N. Virginia: All the Latest on US Data Center Leasing

Data Center Knowledge Editor-in-Chief Yevgeniy Sverdlik interviews Jim Kerrigan, a well-known data center real estate broker in the US who currently leads his own practice called North American Data Centers, on the latest developments in data center markets around the country. Listen to the interview on The Data Center Podcast and subscribe. (Find it on Apple Podcasts, Spotify, Google Podcasts, , etc.)

Read the full transcript of the interview:

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Hey everybody. Welcome to the Data Center Podcast. We have with us today, Jim Kerrigan, he is principal at North American Data Centers, a data center, real estate brokerage. Jim, thank you so much for taking the time today.

Jim Kerrigan, Principal, NADC:

Well, thanks for having me. I appreciate the opportunity.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

To those who haven't bought or sold data center space in the US but pay attention to what's happening in the market, Jim may be best known for his annual newsletter, which sort of spills the beans on all the big recent lease transactions. Companies typically try to keep tight control on this kind of information, such as who Microsoft leased a gazillion megawatts from in Chicago this year, or who's getting all the ByteDance TikTok business as they expand, and so on. So Jim, maybe first, tell us how do you get that information and how do you decide which deals get included in the newsletter?

Jim Kerrigan, Principal, NADC:

Yeah, so like all things it's relationships and having the right relationships with the right people that know what's going on. It's day-to-day knowing who to talk to, who to call and oftentimes it might be someone that may have lost the transaction to somebody else. Maybe it comes from, one of my clients is looking for space in the same property and I find out that somebody else is taking the space. So, it's various resources. As I always say though, I don't ever put my own transactions in there. So if you don't want to be in my newsletter, you hire me.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

So you used to be an analyst, right? You used to be market analyst, and yet you have... It's not just rumors. Those deals aren't just rumors. Right? You have some kind of a verification processes.

Jim Kerrigan, Principal, NADC:

Yeah. I try to make sure... I try to go and vet it through a couple of different sources and most of the time I get it right. But occasionally I get a couple of things wrong and it's not an exact science. I always tell people it's probably about 75%... Or sorry. It's probably about 95% accurate, and the other 5%, I don't know if anyone's going to figure out that portion, because it's just too hard. There's too many dis-information out there. And oftentimes if I hear that a TikTok or a ByteDance is taking down 25 megawatts, I don't know what that is, if that's the initial take-down or if that's the total take-down with incremental free rent prior to that.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

What can you tell us about ByteDance, the company behind TikTok as a data center buyer in the US? It looks like they leased a lot of capacity last year?

Jim Kerrigan, Principal, NADC:

Yeah. So ByteDance took roughly 150 or 125 megawatts, and that was split with three different landlords, Align, Digital... Oh, actually it was Digital, two different locations, and they had taken space in 2019 with Digital as well, but it was a lot smaller. It was about nine megawatts.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Let's rewind. Tell us, how did you get into data center brokerage? You used to be in office real estate, right?

Jim Kerrigan, Principal, NADC:

Correct. So I used to be an office broker and then, in I think it was 1997 or '98, we had an opportunity with my old company to help a company looking for a telco hotel, I think is what the term was back then. And the company was Frontier Communications and I was based in Chicago, and at that point in time, there were a couple of different properties that were trying to become a data center hotel. And the first transaction I did was a 70,000 square foot transaction at 350 Cermak. And ultimately, it was the anchor lease for the property, which is now considered one of the most famous addresses in the world.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

And 350 is... Sorry, I just want to clarify. 350 East Cermak is in Chicago, right? That's a big [crosstalk 00:03:36]-

Jim Kerrigan, Principal, NADC:

Correct? Yeah. It's probably the biggest data center in the world, I think. And it's now owned by Digital Realty Trust. Back then it was being developed by a group out of Washington DC. And so, it was the anchor tenant and I learned... At that point in time, I really didn't understand the power requirements or the fiber requirements, and frankly, I didn't even know what fiber was because it was kind of early on in trying to understand all that stuff.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

That was your first data center transaction. How did you eventually decide that you were going to, this is what you're going to focus on, this part of the real estate market?

Jim Kerrigan, Principal, NADC:

Yeah, what I liked about it, is that as a broker, we were always paid on the size of the transaction, and this was a transaction that essentially came out of nowhere and was done very quickly. And it was the thrill of, okay, you don't have to deal with... Office transactions were all based on the number of people that were going to be in that space. Here's something that had nothing to do with the head count, and it had entirely to do with changing technology.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Were you thinking the technology industry is growing, this is kind of the future, so this is what I should focus on?

Jim Kerrigan, Principal, NADC:

Yeah. So up until then, I had been focused on more software companies and their growth. And based on everything else I was seeing, I thought that was a great technology. This seemed like the next great thing and particularly related to technology and what it was going to need and the buildings it was going to have. And I knew I had kind of a unique requirement and I did try for a couple years until 2001 hit. And then in 2001, when the telco market crashed, I made a pact to myself that I'd never do another data center transaction. Then lo and behold, now I have a company that that's all it does.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

And so, then you've spent years running data center practices at some of the largest real estate companies, Avison Young, Grubb and Ellis. Why did you eventually decide to start your own North American data centers?

Jim Kerrigan, Principal, NADC:

It really was to give me the flexibility to be able to work in multiple markets. The challenge with data center transactions is that we look at different markets for our clients in that sometimes Chicago might be the right place for them and sometimes Dallas was going to be the right place, and without having the ability to be able to do transactions in multiple markets, or being beholden to someone within my company that might not know a market, it was a lot easier to be able to go out there and be able to say, "Okay, well, if I'm going to Dallas, I want to look at this property here. If I'm looking in San Francisco, this makes the most sense." And it just really was trying to deliver best-in-class services in multiple markets. And I didn't see that ability with a large real estate firm.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Was it a matter of the large real estate firm has a certain strategy and that strategy doesn't always gel well with what's best for the customers?

Jim Kerrigan, Principal, NADC:

Yeah. Sometimes. Because sometimes it's based on zip code. So, if you're in suburban Chicago and you're a downtown Chicago real estate broker, you have to find a guy that's an expert in that market. And so, that doesn't always work because within the data center space, there's only a handful of real estate brokers that really know the data center within their market, and they may not necessarily be within your firm. It may be with a different firm. So being on my own gives me the ability to team up as needed with folks that have the expertise that can help my clients.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

So on every data center, REITs earnings call last year, analysts asked about Northern Virginia. It was the largest market in North America, probably still the largest in the world. The analysts were concerned with over supply there with everybody building like crazy. What's the state of play in Northern Virginia today?

Jim Kerrigan, Principal, NADC:

So, at the beginning of the year, it may have been oversupplied, and the rental rates that they were asking for the customers, and the transactions that got done there with Microsoft and ByteDance, they're all very aggressive transactions. And that absorbed a lot of the space. So currently, there's a couple of hundred megawatts under construction there now, but I'm pretty sure that some of it's already been spoken for by some of the bigger customers. So, I feel like there's a pretty good supply demand balance there now, but that remains to be seen. If it has another monster year like last year in Northern Virginia, then they're going to have some issues there with not having enough supply. So, it still tends to be the go-to for a lot of the bigger customers. Last year in our report, we reported that roughly 500 megawatts of the 700 megawatts that was leased last year was done in Northern Virginia.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Can you explain a little bit more about those? You said Microsoft and ByteDance did aggressive transactions there. What does that mean? They were aggressive in terms of pricing?

Jim Kerrigan, Principal, NADC:

Yeah. In terms of pricing. Their rental rates were very low and that's always one of those things that, what is the right number? It's a lot easier with office space to be able to say, "Okay, that's a Class A building, that's a Class B building. Here's what was leased there." And oftentimes people get confused with what the net versus gross rental rate is, and whether PUE is part of it or not part of it. There's all sorts of different factors that we look at. But the rental rates at beginning of last year were very aggressive. And then the pendulum swung back toward the end of the year and went back to kind of where it was maybe in 2019. So yeah, and every year there's different challenges with leasing and renewals and everything like that. But that's how we saw it last year.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Mm-hmm (affirmative). And so those aggressive rates, I think, were part of the challenge that market, that all the kind of analysts were concerned with too. Right? I've heard even some complaints about, "Oh, these companies are... Somebody's leasing capacity at low rates, kind of undermining everybody in the market."

Jim Kerrigan, Principal, NADC:

That's always a concern in any sort of business, right? But it's also, if you're the landlord, what's your basis in the land? And what's your construction costs and what are you building too?

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Yeah, because not everybody can make those transactions pencil out, but some can?

Jim Kerrigan, Principal, NADC:

Well, I'm saying that there's all sorts of different restaurants and not everyone's going to eat at McDonald's every day. And there's different customers that are going to have different sort of needs. And as such, the data centers will also have different sort of constructions. If you look at the 10Ks for most of the public traded companies, they're all demonstrating a different price point of what the construction costs are. And some put it on a price per square foot, some put it on a per megawatt, but you can look at some of those and the price per megawatt, the incremental megawatt might be anywhere from five megawatts to... Or sorry, five million a megawatt to eight or nine million a megawatt. And at one point in time, it was closer to 10. So, that's why I'm saying that everyone does what they have to do to get their deal done. Whether the analysts are concerned or not is of no concern to either the companies or a leasing space or the tenants themselves, because we'll do it for where they think they can best make the market.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Okay, now that we've gotten Northern Virginia out of the way. How are you seeing things playing out in the quote-unquote emerging markets around the US? Do you see a lot of growth outside of the top markets? I know you mentioned Northern Virginia had a huge year.

Jim Kerrigan, Principal, NADC:

No. I mean, I think it's been pretty quiet last year. If we're talking about 500 of the 700 being in one market, then there's only 200 that's spread out over the rest of the country. And that seemed to occur in a couple of markets. Chicago was probably the number one behind Virginia, and then Phoenix was another market that was really strong as well. And I even heard recently that some of what I reported was... I missed one of the Microsoft deals that went to EdgeCore in Phoenix. So then we saw some activity in northern California, and we saw a little bit of activity in Nevada as well. So, those are kind of some new markets, as you're say, emerging, and then a little bit northwest. The one market that still hasn't really captured from a leasing perspective, any sort of major hyperscale tenants, is Dallas.

Jim Kerrigan, Principal, NADC:

And so, that's been an obvious one, where Dallas, and Chicago, and even to some degree, Virginia, they would take over the second and the third spots. But when Virginia, not that long ago, three, four years ago, where they weren't leading the market, it was usually Dallas or Chicago. And Dallas has just not been as strong in the last three or four years. And part of that is the hyperscales that have done Dallas has actually done that either captured something on their own, like Facebook did in Fort Worth, or they're not leasing there for whatever reason.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

And the tier two markets are often positioned as edge markets. How much of that is true? Are there a lot of companies leasing space in tier two markets specifically to reduce latency for users in those metros and cut their own data transport costs? Or is this more of it's just color for markets that are underserved?

Jim Kerrigan, Principal, NADC:

Yeah. I think the tier two markets have for the last several years... And let's talk about tier two, what does that mean? Because it means something different to everyone else than for me. So I would say like a Indianapolis or a Columbus or a Kansas City or a Pittsburgh, I think those are tier two markets. Occasionally we'll see it being an edge market, but oftentimes I think what we're doing is we're seeing hospitals and local companies that are more likely to use that for what they need it for. A good example of an edge sort of platform was EdgeConneX, which that sold last year, and they were really catering to just a couple of different tenants for the edge markets. And that started with the telecommunication companies or cable companies I should say; charter communications and Comcast.

Jim Kerrigan, Principal, NADC:

Those were really what was driving the edge. And then the followup were the companies that would, once they did the anchor transaction, then we'd see an Apple or a Netflix or another group like that come in there. But none of these properties were huge. And the absorption after the initial couple of tenants went in there hasn't been huge. So, a lot of what we think about the edge, and someone explained it to me recently pretty well. And it was one of the smart guys in our space. He explained to me, "Hey, Jim, think about how long we've had video conferencing. It's been around since 1999, but it wasn't until 2020 where we really saw that early explode." And he's saying the same thing that's going to happen to edge is that it may take some while for us to see that and the impact of that, but that it's still coming.

Jim Kerrigan, Principal, NADC:

Because I keep going to these conferences, and I heard a conference in 2019 at the end of the year, and it was, "Oh, 2020 will be the year of the edge." I'm like, "Well, I've been doing edge transactions for the last seven years now. Why is it all of a sudden become new?" So, last year when you think of edge, I could argue edge is Chicago. And I've argued this before. Years ago I argued it when Microsoft did a big transaction out in suburban Chicago. And they did it with EdgeConneX ironically, but I said, "Well, that's really an edge transaction." And everyone said, "Well, how could that be?" And I said, "Well, they're going after Office 365 users. And the application happens to be for the nine million population of the greater Chicago area."

Jim Kerrigan, Principal, NADC:

I said, "Similarly, if you look at gaming last year, that was truly an edge sort of platform. Right? And so, we saw some of the gamers do transactions around the country and not all of them made the newsletter, because a lot of them were under the two megawatt cutoff that we kind of use for the newsletter. But we saw PlayStation do a couple megs in Chicago. I would consider that an edge transaction because they're trying to get the gamers to have the latency so they can play each other on a competitive basis.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Right. So you can look at edge as being a place where you don't have core, so to speak. So, if you don't have infrastructure, if you have internet infrastructure in market A and you need to reach users in Market B, then you build some infrastructure in Market B and that becomes the edge. Oh, you mentioned gaming. So there were a lot of obviously announcements of cloud gaming recently that did drive some leasing, some data center leasing around the country?

Jim Kerrigan, Principal, NADC:

Yeah. It wasn't substantial. Gaming typically ends up being pretty small. Usually gaming's 500 or meg, meg and a half. The deal I talked about in Chicago was two. And I remember a few years ago there was somebody had something new out, and they had a multi-market sort of transaction because they had a new platform that they were introducing. And the name escapes me for now, but there are a lot of things that were driving work for that, besides gaming that was remote. Work, there is social media, there was e-commerce and video streaming. So, all of that drove leasing activity, but it's not always transparent when we see someone like a Microsoft take down space, because we don't know if that that transactions for Bing or if that's for X-Box or if that's for Office 365 or whatever. They've got so many different platforms there that have data center needs. And that's why it becomes less transparent when we see companies like that [crosstalk 00:17:27].

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Yeah, they just call it all cloud. So you mentioned the EdgeConneX build out when they were building data centers all over the country. Primarily, as you mentioned, for these communications companies. I think Comcast was building it out for their cloud DVR product. And they went into all the tier two markets and they were built as multi-tenant data centers. I know you mentioned a few tenants that leased some of that space, in addition to the anchors. I think you mentioned Apple and Netflix. In general, have those facilities been filling up with tenants other than the anchor?

Jim Kerrigan, Principal, NADC:

The anchor has continued to expand some of those properties, but then I don't know how full they are. But once again, these properties... I've been through many of the EdgeConneX facilities, who are much smaller properties in general. They might be 35,000 square feet or 60,000 square feet, which are relatively small in the magnitude of what the larger data center brokers or developers are building. So, I'm not up to speed exactly on how much space is available and what's going on with those sort of properties, so I can't speak to that.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

EdgeConneX has moved on, also... Not moved on, I don't think they've moved away from the edge model, but they've been building hyper-scale facilities. Right? Not just in the US, in Europe as well.

Jim Kerrigan, Principal, NADC:

Well, they did at one time though, I don't know if that's still the case though. And they just sold... So, that was probably very consuming for them, but I don't know what their plan is now. I saw something recently, but I don't know what it was, but they had three successful deployments that were for Microsoft and one was in Ireland and one was in Amsterdam, I believe, but that's all I know about what they did.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

In your last newsletter, which just came out recently, you bring up an interesting concept, power reporting. Can you explain what it is and why there's more of it happening now?

Jim Kerrigan, Principal, NADC:

This goes back to my days as an office broker, when there was a company called Equity Office Properties; Sam Zell was the CEO of that company. And what his whole opinion was, he tried to make it as simple as possible for companies to lease space with them. And he didn't care if you leased 300,000 square feet or 30,000 square feet, he wanted you to have the flexibility for you to keep on using the EOP model into multiple markets. And so, we're seeing that more and more with [crosstalk 00:19:54]-

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

I'm sorry. What's the EOP model?

Jim Kerrigan, Principal, NADC:

I'm sorry, Equity Office Properties. So Equity Office Properties was one of the biggest landlords of all time. And they sold, I can't even remember how many years ago. I think they sold to Blackstone 10 years ago, but in the late 90s, it gave my clients the ability to port their office space requirements to different markets. And I'm seeing that more and more now with data center requirements, where if I don't have the need for the space in Ashburn, then I can move that to another facility within, a digital realty in Santa Clara, or vice versa. And so, it's an interesting concept that's now the data center REITs are catching up to what the office space did in the past.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

I guess it takes some special consideration for them, too, right, because it complicates, I imagine capacity planning in various markets?

Jim Kerrigan, Principal, NADC:

Yeah, but I mean, the question is, how do you keep a customer for... As you've talked about before, and I've read in some of your articles, why does that one customer not go from one provider to the other? If you can create some flexibility in your leasing process, then it makes it easier for... They tend to accommodate. And maybe it's a gaming company that says, "Okay, we've got a lot more demand in certain markets. We thought we would have a lot more demand in this one market, but we didn't have the kind of gaming demand we had in that market. We could move it somewhere else now." So, it creates more flexibility and more benefits to the customer.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

And you focus on wholesale data center leasing, as you mentioned, even for your newsletter, you have the two megawatt cutoff. So deals under two megawatts, you don't include in there. And there's two types of wholesale leasing, right? There's single tenant building leases and multi-tenant ones. How are those transactions different from one another?

Jim Kerrigan, Principal, NADC:

Well, most of the single tenant transactions are really the hyperscale guys who have negotiated that either prior to the building being built, or they come in there with the demand of taking down either the entire space or a commitment, some sort of forward commitment to take down the entire space. Where the multi-tenant data center transactions, which is more common to what we see for most of the landlords, those tend to be anywhere from 300 KW to four or five megawatts.

Jim Kerrigan, Principal, NADC:

We have seen some of them that might be as large as 10 megawatts, but most of the multi-tenant data center leasing is going to be probably at a much higher rate than the single tenant properties. The rental rate will be much higher. And then with the single tenant properties, you have the ability to modify the construction. So you might have an end design versus an end plus one or a two end design. So whatever that landlord was anticipating that he was going to build, he might be flexible and accommodate a tenant. In a multi-tenant data center environment, you might have hard walls and now you decide, "Hey, you don't need that because they're taking down the entire facility." We don't need to put a hard wall up, so therefore we can utilize the space a little bit differently.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

And we talk a lot about new leases, but a big part of the business is in renewals. How is negotiating renewable data center leases different from new ones?

Jim Kerrigan, Principal, NADC:

Extremely difficult. It's super hard because it's based on language that could be 10 years old. It could be 15 years old, and then talk about the renewal language within your lease document might dictate that it's at market, and market would it be based on factors that was important at a period of time that's not the same these days. And so, the challenge is that how does the landlord and the tenant get to the right number, and what does a tenant feel that they need to get things done?

Jim Kerrigan, Principal, NADC:

They're extremely hard to deal with. 2018 and 2019 were two years where there was a significant amount of renewals that were being done and had to get done. And for the most part, landlord and tenant eventually got to the right number because otherwise those tenants probably wouldn't have renewed, but I've seen cases where both parties just walk away and they kind of are... They're a tenant that doesn't necessarily have a renewal, but they have a lease in place. It's challenging. It certainly is. It's much more challenging in this space than practically any other space, any other real estate space that exists.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

And so, in having done a few of these, what's your advice to a company whose lease is coming up for renewal in the data center?

Jim Kerrigan, Principal, NADC:

It's got to be one of those things that you have to start early. If your lease is up in a year from now, that's probably not nearly early enough. You really have to probably be out there two years in advance of your lease, and you really have to explore the market, and you have to understand how you're utilizing the space. So, if you have five or six megawatts, and you leased that space 10 years ago, you're probably utilizing it a lot differently than you once were. And just because you have, let's say five or six megawatts, you might only be utilizing or needing three of that, but that three megawatts may be spread over 40,000 square feet. And there's got to be a trade off between the cost of staying and the cost of moving.

Jim Kerrigan, Principal, NADC:

In that if you gave back, call it half your load, and then you're able to build that space out much more efficiently in a new location, it really gives you a better understanding of whether or not it makes sense to stay at that location or whether it makes more sense to move. And yeah, I've been involved with a number of renewals over the years, and the first renewal I think I did of a data center was probably in 2007 or something like that. And that was another difficult one, I can remember, because the language was so difficult. It was all based on not necessarily the data center improvements, but it was based on similar buildings in that geographic area. So it had nothing to do with data centers.

Jim Kerrigan, Principal, NADC:

And I had another renewal where the tenant had taken space down from a full floor tenant, so the whole, all the equipment was all chopped up, and it was just difficult. None of them are easy, but there are some landlords that are good to work with and they understand the challenges because they're in the midst of dealing with that as well. So it always helps when you have a good partner on the other side, but I'd say for the most part, companies that pursue a strategy like this on their own are going to have a tough time going at it. It's better to hire someone like myself or one of my friendly peer group to help you through that process.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

The landlords must be especially sensitive nowadays because they're competing with cloud providers. Right? I bet a lot of leases that come up for renewal just become cloud deals instead of renewal.

Jim Kerrigan, Principal, NADC:

Yeah. But then there's still the hybrid cloud. Right? So then you'll still have someone that says, "Okay, we still want to have some in that particular location," but that's where I think I'm describing what it is. And let's say, the tenant's two megawatts and wants to offload some of that into the cloud, and now he's down to one megawatt, but the suite that he's in was designed for two. And then the landlord says, "Okay, well, if you want to stay here, I'm going to have to chop this up. And you're going to have the share this suite with somebody else." And how that's handled is always the challenge. Right? And it's the challenge for both the tenant, the landlord, and for the other tenants that are going into that space, because then you get into more, almost a co-location environment than having a private multi-tenant data center suite.

Yevgeniy Sverdlik, Editor-in-Chief, DCK:

Okay. Jim, that's all I have. Thank you so much.

Jim Kerrigan, Principal, NADC:

Thank you. Appreciate your time. Have a great day.