Data centres have emerged as the new sought-after alternative commercial real estate investment asset class globally. The growth in the demand for data centres has been driven by the accelerated adoption of digital services across the globe during the pandemic; an explosion in data consumption, which is expected to rise from 64 ZB in 2020 to 181 ZB in 2025; and increased emphasis by cloud and other service providers on improving data storage capacities to meet the growing demand.
Global investment trends
A performance analysis of data centre real estate investment trusts (REITs) in the US shows that in 2020, data centre REITs have been the best performing, offering an annual total return of 21 per cent. Further, over the past six years, data centre REITs have been consistently outperforming other REITs. This is likely to be the trend in other parts of the world as well.
Another recent trend in the global data centre space has been the latest acquisitions in the sector. This has been driven by the surging investor interest in the sector with an influx of cash and large merger deals. Moreover, large institutional investors have been consolidating their data centre portfolio through large acquisitions. Consolidation is happening today because a lot of institutional and private equity investors have started looking at data centres as an alternative real estate commercial asset.
Data centres emerging as the new asset class
The emergence of data centres as the new asset class is driven by a variety of factors. Key among these is the need for diversification into alternative yield assets. While data centres are essentially a real estate class, they have highly specialised functions. They have a long lease tenure of around 10-30 years, with clients (especially hyperscalers) that help in completely eliminating the downside risks of vacancy. Further, data centres create an additional earning potential by offering bundled services such as interconnection, managed infrastructure, security, etc. Another advantage is their high customer stickiness not just on price, but also on a variety of critical technical criteria. Additionally, data centres have emerged as a favourable investment avenue amidst saturation of opportunities and compressed yields in conventional real estate assets in certain markets.
The key driver propelling the demand for data centres in India is the rising number of internet users in the country. For instance, the country has around 350 million social media users at present, with the growth in users being almost 20 per cent over the past five years. Further, in 2014, each user consumed only 300 MB of data per month while in 2020, this rose to 13 GB data per month. In 2025, we are expecting this to double again with the total data traffic projected to reach about 21 EB per month. All this data needs to be stored somewhere, thereby propelling the rise in demand for data centres. Moreover, cheaper data tariffs in India, affordable smartphones and feature phones and the rising use of cashless payments triggered by demonetisation in 2016 are acting as a catalyst for the quick adoption of digital services.
Another key driver has been the government’s move towards data localisation. This move followed the government’s realisation of the potential of data and the criticality of data protection. With the proposed rules for data localisation under the Personal Data Protection Bill, steps to ensure data sovereignty have been initiated. Under these rules, data needs to be physically stored in India, which will, in turn, increase the demand for data centres.
Investments in India
The total revenue of the Indian data centre industry has grown by about three times (20 per cent per annum) over the past seven years. The revenue increased from $386 million in 2014 to $1,151 million in 2020. In terms of investments, historically, largely international capital has flowed into the data centre industry till date. However, with changing times and growing demand for data centres, even domestic private equity players are gearing up to enter the fray.
In fact, 2021 has been a notable year for the industry. During the year, the country received strategic investments of $150 million for the actual deployment of data centres. Further, there has been a shifting trend towards creating platforms that are directed towards a future REIT listing. For instance, recently, three large platforms have been announced to increase investments in the space. These include the EverYondr platform committing an investment of $1 billion, the BAM-Digital Realty platform worth $2 billion and the Kotak-Sify platform, committing an investment of $135 million and a potential of $530 million for new data centre opportunities.
Moreover, hyperscalers are also committing to invest in digital infrastructure in India with Google committing $10 billion, Amazon Web Services committing $1.6 billion and Microsoft committing $2 billion.
Key stakeholders in the investment structure
The data centre value chain comprises key stakeholders that are a part of the investment structure. These stakeholders include data centre operators, investors, data centre developers and infrastructure providers. The data centre operator is responsible for data centre design, operations and meeting customers’ needs while the investor supplies capital. Data centre developers handle the complexities associated with land acquisition, government permits and the construction of the data centre. Since power is a critical infrastructure requirement for data centre projects, infrastructure providers such as renewable energy developers who can commission solar/wind plants under captive/group captive schemes need to step in to ensure sustainable data centre operations.
Risks associated with data centre investments
The key risks associated with data centre investments are as follows:
- Heavy capex: The heavy capex is a challenge as there is an increased risk of speculative developments (between $5 million and $7.5 million per MW).
- Unique asset class: The interplay of real estate, infrastructure and technology needs careful evaluation in underwriting costs, revenues and risks.
- Land acquisition risk: Land acquisition in India is complex with possibilities of issues regarding titles, government records and transfer approvals/charges, permissibility of land use, etc.
- Multiple stakeholders: Managing multiple stakeholders requires seamless transaction and project management.
- Technology risks: Stakeholders need to factor in mitigation for risks such as technology obsolescence, automation, and need for data compression.
- Operational risks: Stringent service-level agreements and consequences of breach can have enormous liability impacts.
Challenges and upcoming opportunities
Going forward, the Indian data centre space is expected to present a plethora of opportunities for stakeholders across the value chain. With a mere 596 MW of operational capacity at present, there exists a huge potential for meeting the current and future demand for data centres. The country offers a level playing field for operators, given the nascent stage of growth and limited acquisition possibility of ready assets. Moreover, smaller edge facilities for Tier 2 and Tier 3 cities provide an early-mover advantage.
Additionally, India’s strengths in the form of the huge demographic advantage with 67 per cent of the population being within the ages of 15-64 and being active consumers of data make it a favourable destination for data centre investments. Further, the government’s data localisation norms put a legal onus on operators to store data within the country, which will increase the demand for data centres. Another advantage that India has is the presence of a large affordable workforce pool.
However, despite these advantages, significant headway needs to be made in terms of fiscal and regulatory support at the national and state levels to enable growth in the industry. This is because local approvals and liaisons can be time-consuming and complex. Further, there is also a partner risk associated with the market at present, given the limited established local partner options for global players. The other threats that need to be ironed out include power outage possibilities that could dampen the prospects of India becoming a regional data centre hub; state-wise regulatory discrepancies in generation and procurement of renewable energy that can hamper sustainability in operations; and higher development costs due to vertical developments (given the preference to be closer to data density), which makes speculative developments risky.
Based on a presentation by Devi Shankar, President, Industrial and Logistics, Data Centres, Anarock, at a recent tele.net conference