Analysts: Demand Still Outpacing Supply

Demand for data center space continues to outpace supply in most major markets, according to analysts and real estate executives, who say the imbalance is most pronounced in the market for wholesale "plug-n-play" space.

"Demand is far outweighing supply," said Antonio Piraino, the Research Director of Tier 1 Research. "The demand is extremely healthy. We’re seeing more and more cloud computing providers coming into this space. It’s just a great opportunity for the data center space."

Leases Absorbing Wholesale Space
Leases for more than 400,000 square feet of wholesale data center space were signed in the first quarter of 2010, according to Grubb & Ellis' National Data Center Practice. Nationally, there are just six single-story properties with more than 30,000 square foot of raised floor space built out and available for occupancy today, according to a recent analysis by Jim Kerrigan and Bill Moser of Grubb & Ellis.

The limited supply of wholesale space in key markets has prompted some large users to move aggressively to secure space. Chief among these is Facebook, which in March leased much of the available wholesale data center space in two major markets, Santa Clara, Calif. and Ashburn, Va.

Hosting companies have also been active in the market, particularly in Chicago, where leases from ServerCentral and Rackspace for nearly 6 megawatts of power/space helped DuPont Fabros Technology helped fill up its data center in the western suburb of Elk Grove Village.

"Hosting has begun to show signs of recovery," said Piraino. "Hosting had a tremendous slowdown in 2009. The growth has picked up again, particularly for managed hosting providers."

New supply is coming on the market, especially in Santa Clara, where there are active construction projects for Digital Realty Trust (DLR), DuPont Fabros (DFT), Terremark (TMRK), CoreSite and newcomer Vantage Data Centers.

Haunted by History
Some market watchers get nervous when they see a flurry of data center construction. The overbuilding and data center glut from the cot-com bust left their mark on the industry. That period is often referred to as the “Field of Dreams” era, when leading data center and colocation providers borrowed heavily to pursue a strategy of “build it, and they will come.”

When the Internet market crashed, the customers never came, and many of the overbuilders wound up in bankruptcy, leaving gorgeously-engineered $100 million data centers sitting empty, to be sold for pennies on the dollar.

The distressed asset sales of 2001-2003 helped many of today’s leading providers acquire quality facilities cheap. But the pain on the other side of the transaction was acute, leaving investors, landlords, lenders and analysts with long memories of the industry’s nuclear winter.

As a result, there's a deep-seated reflex in some quarters to be skeptical of strong demand and pose the question: Is this another round of overbuilding, setting the stage for oversupply and future disaster?

What's Different Now?
There are several important differences between the data center industry of today and that of the dot-com boom years. Most of the current crop of companies and executives are survivors of the "Fields of Dreams" era, and made plenty of mental notes about common mistakes to be avoided.

Data center developers like Equinix and Digital Realty Trust track demand closely, conducting regular surveys of their customer base and the marketplace to assess the supply-and-demand dynamic. This is crucial for in-house capacity planning as well as reassuring lenders and investors.

The other big change is in the deployment of capital. Data centers are still plenty expensive, but are built very differently. Companies like WorldCom and AboveNet invested $100 million at a time to build out "barns" - complete raised-floor data centers spanning more than 100,000 square feet of space - before they had any customer commitments.

The building methodology of 2010 is based on a "pod" approach that allows for a phased build-out in chunks of about 8,000 to 10,000 square feet at a time. This also allows for repeatable design, which shortens the construction phase, allowing companies to move closer to a "just in time" model in which supply can be more closely linked to demand.

Most significantly, the demand is driven by a wholesale shift toward using the Internet for business and entertainment, a shift that is generating enormous volumes of data and growing requirments for data centers and network infrastructure to support it.