How AI Is Shaping the Future of Data Center Financing
Discover how AI impacts the industry, driving growth, sustainability, and innovative funding approaches.
While data centers have been operating for over 20 years now, they’ve only recently become more recognized in the real estate investing community. Today, they’re part of the most popular and promising asset class in commercial real estate – growing faster than most other asset classes, says Julie Brewer, SVP of finance at EdgeCore Digital Infrastructure.
Fifteen years ago, we saw a limited number of commercial real estate investors and lenders active in the data center space. Both are now starting to gain more familiarity with the industry. The demand for capacity continues to snowball, and today, we’re seeing private equity investments reaching record highs in 2022 and 2023.
As development demands for data centers continue, navigating the challenges of securing debt financing will be critical. Now that we’re in the era of AI – on top of heightened expectations of investors, communities where data centers are located, and regulators on ESG(environmental, social, and governance) and sustainable operations – striking a balance between debt financing and equity capital is critical. Data center developers must be intentional when determining the optimal capital structure for everything from construction to serving customers for their unique capacity needs.
Critical Factors of Data Center Financing
Commercial real estate assets are relatively straightforward investments. Operators and private equity backers are always looking to extend capabilities that continue progressing due to the demand for capacity.
Cost to build, lease rates, debt availability, and asset valuations drive data center economics. The need for greater power and cooling infrastructure differentiates data centers from other commercial real estate assets, creating a unique learning curve for lenders. As tenants’ appetite for scale data center capacity grows, and lenders and investors become more familiar with the industry, data centers have become a key sector in commercial real estate. The growth in available capital only continues to increase.
Navigating Market Trends
Data centers drove a significant portion of debt financing activity during the first half of 2023 – and the pace hasn’t slowed in the back half of the year. While the current investing climate is at a higher risk and cost, demand for capacity continues to achieve record highs. Although current interest rates and inflation drive costs, the debt markets remain open to the data center space.
Data centers have unique fundamentals that make them an attractive space for capital investments. High-credit tenants and long-term leases offer attractive investing fundamentals. Tenants’ migration complexity and significant tenant investment only further attract capital to the space.
While capital markets are somewhat volatile now, maintaining solid relationships with lenders is critical, especially as the industry matures and grows exponentially. Lender relationships are key so data center providers can keep up with the evolving debt market and ensure their access to liquidity as needed.
See More: Emerging AI Technologies and the Future of Data Centers
Raising Funds With Sustainability as the Basis
Lenders and investors want to ensure that power supply is available and used efficiently to support data center developments and operators’ commitments to their campuses. The ability to secure power and develop land for scalable campuses is critical. Lenders and investors want to ensure that every campus has a secure pathway to power, which also highlights the importance of data centers’ close collaboration with utility providers.
Understanding the importance of sustainability for all stakeholders – lenders, investors, providers, neighboring communities, customers, and regulators creates a key focus of debt financing and private equity initiatives. A pivotal avenue to achieve this includes focusing on regions that increase the pool of potential customers and purposefully designing facilities to performance standards.
Campuses and facilities should be constructed with intent – the intent being the ability to meet these standards. This is particularly attractive for providers, developers, and customers as it offers valuable tax incentives. Green building standards also influence decision-making on project development. The financing sector understands the importance of green power. For example, we see green bonds rising since they are more suitable and help meet the overarching demand to achieve a greener environment.
Customers, lenders, investors, and the communities where data centers operate are laser-focused on sustainable operations, which can be achieved through additional tools. For example, Power Purchase Agreements (PPA) work by purchasing power and generating Renewable Energy Credits (RECs) from the project. Securing this green power is also crucial to further growth and expansion while meeting the demands of the market and customers.
The Impact of Generative AI
Understanding data centers’ progress in lending and commercial real estate communities is only one piece of the puzzle. Now that generative AI impacts all businesses – including data centers – we can expect more changes.
AI pushes data centers to be larger and denser as graphics processing units (GPUs) require over three-and-a-half times the power of standard central processing units (CPUs). AI requires total power allocations sooner to fully utilize GPU clusters versus cloud data centers, which historically would ramp into the full power demand over a few years.
For example, the most significant 100+ MW AI-driven buildings today would have been unheard of a few years ago and are roughly two to three times the size of the most important cloud data center buildings in 2015. Those cloud data centers were, in turn, two to three times the size of the largest enterprise data centers in 2007, which were two to three times the size of the largest telecom/dotcom data centers in 1999.
It’s without a doubt that AI is adding to data center demand that’s already robust. We’re seeing major cloud players pioneering the way, such as Microsoft’s heavy investment in OpenAI and the integration of ChatGPT within the Windows suite and Bing.
Additionally, Nvidia’s $1.25 trillion market capitalization has been propelled by the recognition of Nvidia GPUs as the driving force in the generative AI boom. From a data center owner perspective, the AI-related requirement for Nvidia hardware has created a fourth-generational shift in the size, shape, and scale of each development and a massive wave of demand for building capacity that can support the hardware.
Developers building to the next generation of data center demand, in terms of size, density, and power, will be best positioned to support AI hardware needs.
Factors in Data Center Financing Moving Forward
The high growth in data centers as an asset class will lead to evolving approaches to debt financing and equity capital. Developers must design and construct facilities to meet capacity demands and sustainability expectations, procure land and power to support future development, and secure the necessary capital for all of the above. As demand for capacity grows, AI is introducing an entirely new generation of data centers, which will require new approaches to securing capital, including cost to build, valuations of assets, lease rates, and more.
How is AI transforming data center financing? Why is sustainability crucial for investors? Let us know on Facebook, X, and LinkedIn. We’d love to hear from you!
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