Here's What's Driving Private Equity's Interest in Data Centers

Private equity firms have become key players in the building of new facilities and the acquisition of existing data centers as they bet on an ever-increasing demand for big server farms. The scale of investments can be huge with the $15 billion takeover of CyrusOne by KKR and Global Infrastructure Partners being the largest private equity-funded deal of 2022.

Investors have identified the data center segment as able to generate above-average growth from cloud and content users. Data centers are desirable investments for private equity funds as they have stable tenants with low churn levels especially those in markets with low data center penetration. 

Private equity providers now account for a large share of new data center developments with firms looking to build in new U.S. metro markets. Fueling this boon is the acquisition or merger of 92 data centers since January 2022 totaling $41.5 billion according to PitchBook data through August 25. 

New Market Development Fueling Data Center Investment

Additionally, established data centers are using partnerships with private equity investors to fund entries into new markets. Most new data centers being built in new metro areas are fueled by private equity money. Real estate companies like Lendlease are creating joint ventures, like its first data center in Tokyo, Japan with a private equity partner to spread the cost and risk of a large data center investment.

John Dinsdale, a chief analyst at Synergy Research Group says the future looks bright with double-digit annual growth expected in 2022 alone.

“The trouble is that building and operating large fleets of data centers is highly capital intensive. Even the biggest data center operators have had to seek external funding to allow them to meet growth targets while protecting their balance sheets. As the level of resulting M&A activity has shot through the roof, virtually all of the incremental investment has come from private equity,” Dinsdale said. 

According to IT research firm Gartner, the projected worldwide spending on data centers will grow to $226 billion in 2022, up 11.4 percent from 2021.

Still, the speculative nature of the investments seems a safe bet due to the rapid emergence of  AI, the surge of streaming, 5G networks, autonomous vehicles, and the internet of things. The COVID-19 pandemic, which accelerated a more digital and cloud-based workforce, has also increased the demand for data centers globally, particularly in Asia. 

Although the United States accounts for about 40 percent of the world’s large cloud and internet data sites, investors are looking to Asia to facilitate expansion. The latest Datacentrepricing (DCP) research reveals massive investments are being made in data centers by private equity investors, particularly as private equity funds focus on markets where there is a shortage of high-quality, hyper-scale data center capacity.

Asia’s tech boom is fueling interest as investors hope to capitalize on the move to 5G mobile internet and governments and companies increase their computing capacity. The rising competition between companies and U.S.-China geopolitical tensions have also boosted demand for data storage run by independent third parties. Launching in Asia means they can take advantage of lower land costs according to the DCP report. In effect, private equity funds can take more risk for a longer period of time than an established data center provider. 

But market short-seller, Jim Chanos challenged the rosy outlook and is raising capital to bet against data center REITs.  The companies that feature most heavily in the future new data center pipeline are Amazon, Microsoft, Facebook, and Google. They are also the biggest customers for data servers and are building their own facilities. Chanos sees them as the main competition to data centers. Eventually, he sees the cloud providers taking the lion’s share of any future growth. 

Despite these uncertainties, valuations still look high for data centers.