Data proliferation continues rapidly, with advancements in artificial intelligence intensifying demand in one of the technology sector’s most pressing areas of need, according to Morgan Laughlin global head of data centre investments at PGIM Real Estate.
“Data centres providing cloud services are at the heart of the computing industry, essential for all online activities, social media and gaming, and with the development and adoption of artificial intelligence, they are set to play an even more critical role,” he told FSA in a recent interview.
“This is driving strong growth in the space,” said Laughlin (pictured). The global co-location data centre market is set to expand at a compound annual growth rate of 11.3% through to 2026.
Data centre tenants fall into three main segments: retail, enterprise, and hyperscale. Retail caters to customers looking for smaller power commitments, typically less than 1 megawatt (MW), that share space with other customers in a co-location data hall. Enterprises lease and operate their data servers (consuming 1-5MW) in data centres, and hyperscale tenants such as cloud service providers Microsoft and Google and occupiers such as Apple and Meta consume vast amounts of data centre space, typically 5-50MW.
“Hyperscale is the fastest-growing segment by far, expanding at 22.6%, or multiple times faster than both the retail and enterprise wholesale markets,” Laughlin said.
Storage capacity, while expanding, lags amid supply constraints, fostering conditions conducive to long-term growth in digital infrastructure. Indeed, Laughlin believes the supply-and-demand dynamics create a “generational opportunity for data centres and for investors”.
Data centres are the “physical backbone of the internet, ultimately facilitating our digital lives”. They are large industrial buildings that house racks of computer servers that store data and connect internet traffic. The buildings are connected to high-voltage power, as they consume large amounts of energy and are connected to end-users via telecommunication networks.
“Once seen as a niche segment within the real estate sector, data centres are evolving into a mainstream growth industry for the overall real estate industry. This is because they sit at a critical intersection of real estate, infrastructure, and technological advancements like artificial intelligence,” said Laughlin.
Gaining investment exposure
There are two main ways to gain exposure to data centres. One is to invest in a public data centre REIT or a private fund, which typically are comprised of portfolios of stabilised assets. The other way is to make direct property-level investments in the buildout of new data centres.
Suitable for investors with lower risk profiles, the former approach can earn decent income while offering capital appreciation potential.
However, “given the huge supply-and-demand imbalance, we find it more compelling to capitalise on the opportunity through direct property-level investments, which often offer much higher return potential,” said Laughlin.
“While development opportunities are typically considered higher risk because exit values, sales timing, and other related considerations are unpredictable, the supply situation and strong demand tailwinds significantly mitigate risks related to these factors.
“There are compelling development margins to be gained by capturing the spread between development yields and lower estimated exit caps to meaningfully increase return potential for investors.
PGIM Real Estate mainly use a globally diversified “build-fill-sell approach”, where it partners with leading data centre operators to build new data centres for hyperscale customers. It seeks to build state-of-the-art, high-efficiency data centres designed to minimise the environmental impact of the growth in digital infrastructure.
“There are high barriers to entry in this market due to the capital, experience, and relationships required for success,” said Laughlin.
The firm’s dedicated data centre team sources property opportunities based on market demand and partners with appropriate data centre operators, whether regional or global, based on the nature of the opportunity and/or tenant profile.
It then fills the centres with hyperscale tenants to maximise occupancy and optimise revenue potential.
“Once they are established as stabilised properties, we seek to sell the data centres into strong market demand from income-seeking investors like REITs and private equity firms,” said Laughlin.
PGIM Real Estate focuses on the hyperscale segment, which is primarily made up of investment grade credit-quality tenants with strong balance sheets. These tenants tend to lease large amounts of space with growing needs for capacity in current locations while concurrently expanding into new markets.
“This is a low-churn market due to large upfront tenant investments, long lease terms in the five-to-15-year range, and above average probability for renewal upon lease expiration given the potential negative customer consequences associated with relocating facilities,” said Laughlin.
PGIM Real Estate has been expanding its data centre capability since completing its first investment in the sector over a decade ago. Its dedicated data centre team averages over 20 years of experience and is integrated into global infrastructure that leverages more than 300 investment resources. It has $1.5bn invested and available to invest in data centre projects, with a pipeline of upcoming opportunities.
