After Beating Its Own Leasing Record in 2016, DuPont Fabros Keeps Foot on Gas

Looking back at 2016, there was very little wholesale data center leasing by enterprises compared to leasing by hyper-scale cloud companies – and even those large deals dried up towards the end of the year. The November election has often been cited as a reason, along with a lack of available large data halls in top markets.

The 2016 data center REIT results are in the book. However, a nagging question which has yet to be fully answered is: What is the new normal for wholesale leasing in the top US data center markets? Another "new normal" that's unclear is the cost per megawatt for hyper-scale deals.

Can Record Leasing Continue?

DuPont Fabros Technology, one of the biggest data center landlords for hyper-scale companies has had a lot of success during the past couple of years with its 100-percent focus on wholesale deals. The company surpassed its own 2015 leasing record of 47MW of bookings by signing 51MW across its three active markets in Northern Virginia, Chicago, and Silicon Valley last year.

Read more: Surge of New Capacity Expected in Top US Data Center Markets This Year

In the fourth quarter, the data center REIT signed a full-service 2.88MW pre-lease with a new strategic cloud customer. Subsequently, it signed one additional 4.2MW lease this quarter, boosting the occupancy of its ACC7 data center in Ashburn, Virginia (its biggest market) to 100 percent. The company's operating portfolio of 287.1MW is now 99 percent leased, leaving about 2MW available for leasing.

While these results may seem to indicate that opportunities are decelerating, the developer's Q4 earnings call last week showed that that's not the case.

Entering the Phoenix Market

DuPont Fabros has entered into a contract to purchase 56 acres in the Phoenix market, the company's CEO, Chris Eldredge, announced on the call. He noted that the land parcel is located in Mesa, a Phoenix suburb, due in part to attractive development sites being difficult to find in Chandler, where much of the Phoenix market's existing data center capacity is located.

Notably, Mesa is where Apple is also building a huge, $2 billion data center.

The current plan is for DuPont Fabros to hold the parcel in its land bank until a suitable pre-lease is executed to initiate development. Meanwhile, Eldredge is searching for sites suitable for more development in Ashburn, Chicago, and Silicon Valley.

Development Accelerates in 2017

This year the data center REIT plans to have active development underway across five different projects, totaling 64.4MW, most of this capacity expected to be delivered before the end of the year. The company has already pre-leased 18.9MW of this future capacity.

It expects to spend $600 million to $650 million in capital this year, which is both a record for the company and ahead of guidance given just 15 months back, at Investor Day 2015.

This guidance includes delivering the spec shell of ACC10 in Asbhurn in hopes of snaring a hyperscale cloud or a similar build-to-suit. DuPont Fabros acknowledged that speed to market has become more important, so it is accelerating development of the shell in Ashburn to be competitive.

See also: Digital Realty Signals the Gloves are Coming Off in 2017

Eldredge confirmed that the company's first Toronto data center is on track to open with 6MW in the former Toronto Star printing facility in this year's fourth quarter, along with another 12MW of future capacity for Phase I. Meanwhile, the Hillsboro "wheat field" outside of Portland, Oregon, is in pre-development phase, with the first data hall anticipated to be delivered in the second half of 2018.

If early pre-leasing were to occur at ACC10 or Phase II of CH3 in Chicago, that would result in additional capital expenditures, not currently budgeted for 2017.

Few Shots Across the Bow

Eldredge made it a point to clarify that all his publicly traded competitors are acting rationally when it comes to pricing massive cloud deals. This was not the case, however, in a recent deal in Chicago signed by a a private equity-backed provider, whom he did not name but was apparently referring to EdgeConneX and the big lease it signed with Microsoft.

He underscored that despite a competitive market, "The strong demand from cloud providers has resulted in strong ROIs from our recently completed facilities." He provided additional color on ACC7 Phase IV, which delivered an unlevered ROI of almost 14.5 percent, "well above our target return."

On the call, CFO Jeff Foster didn't pull any punches when it came to the all-in cost per megawatt for the product that DuPont Fabros is delivering in each market:

Ashburn: The estimated cost per megawatt is $8.9 million to build the ACC9 N+1 product.

Chicago: DuPont increased the total megawatts of CH3 from 25.6MW to 27.2MW by lowering the redundancy of the building from N+2 to N+1. This lowers the estimated cost to construct CH3 to $10.25 million per megawatt, which is comparable to CH2.

Santa Clara, California: Development cost at SC1 Phase III is projected to be $10.2 million per megawatt, compared with the $12 million per megawatt cost for the first two phases of SC1. The decrease was due to Phase III being constructed at a higher density and some unspecified design changes.

Toronto: DuPont Fabros is building its flexible 4.0 design. Maximum critical load for TOR1 is 46MW. However, the final megawatt for critical load in this building will be dependent upon customer selections. DFT is delivering four rooms at opening, which are being constructed at 1.5MW per room and N+1 redundancy. The initial cost is estimated to be $10 million per megawatt, and Foster is underwriting 13 percent ROI.

Portland: Notably, the 4.0 design will also be utilized in Portland.

The level of cost detail he offered was unprecedented as far as data center REIT disclosures go and appears to be intentional, an effort to increase transparency in the industry regarding development costs.

Investor Takeaway

When it comes to evaluating and entering new markets DuPont Fabros has been measured and methodical. Eldredge made it clear that the company is considered a partner by its major cloud customers and is part of the long-term planning process.

Eldredge assured the analysts on the call that DuPont Fabros is competitive on hyper-scale deals and can achieve its targeted 12 percent-plus unlevered returns on invested capital. One area for investors to watch going forward will be the renewals of the Facebook leases in ACC4, ACC5, ACC6.

DuPont Fabros revealing its all-in cost per megawatt in each of its top markets once again begs the question: What does it really cost to deliver a megawatt for massive hyper-scale cloud data center capacity? I think the ball has now moved back into CyrusOne's court to clarify what is included in its $6.3 million per megawatt budget.