Experts Predict Development Slowdown, More Power Problems

Experts Predict Development Slowdown, More Power Problems

After more than three years of unprecedented boom times, data center industry leaders anticipate mounting challenges and a rapidly shifting landscape for the sector in 2023.

Experts Predict Development Slowdown, More Power Problems

Eight industry insiders spoke with Bisnow about their predictions for the trends, changes and challenges that will shape the data center landscape in the year ahead. While the details revealed in their crystal balls varied, some common themes emerged, with a prevailing sense that 2023 represents something of an inflection point for data centers.

Many of those who spoke with Bisnow expect the pace of growth to stagnate or slow, while power shortages like those seen in Northern Virginia last year are expected to become more commonplace across major markets. New development is expected to accelerate in smaller markets compared to traditional data center hubs, increasing the industry’s geographic diversity even as continued consolidation reduces the total number of data center operators. 

“Some definite shifts are afoot,” said Michael Rechtin, a partner and head of the data center practice at Seyfarth Shaw.

Here are the trends and dynamics that experts predict will shape the data center market in 2023:

Economic headwinds and supply chain woes could temper growth.

With data center tenants facing tough economic choices and no end in sight to the supply chain issues limiting new construction, most experts predict the pace of new development and the industry’s overall growth will stagnate or slow in the year ahead.

Although demand for data center space remains robust and continues to outpace supply, operators are anticipating a temporary dip in demand growth as tenants react to economic headwinds by cutting spending and re-evaluating capital projects. Companies like Omaha-based 1623 Farnam are expecting longer sales cycles in 2023 due to these factors, even as they are bullish on overall growth, according to Executive Vice President Bill Severn. 

The turbulent macroeconomic conditions will also likely slow things down on the development side, at least for a while, said Phil Rafferty, president of data center design and construction firm Data Specialties Inc. He said this pattern has repeated itself during times of economic uncertainty. 

“At the beginning of the pandemic, we saw an initial decline in data center builds as U.S. companies tried to decide whether or not it was the right time to build, expand or upgrade their data centers,” Rafferty said. “We are seeing a similar response now.”

The most significant factor limiting construction of new data centers, however, continues to be supply chain challenges that experts say are unlikely to dissipate in 2023. Lead times of one year or more on items from construction materials to control boards and server racks remain the norm. And with no end in sight, there’s widespread pessimism about the possibility of accelerated development timelines in the year ahead. 

“I think the industry will unfortunately continue to see the impact of the supply chain challenges on the construction side of the data center industry,” said Kevin Dalton, chief data center officer at Cumulus Data. “The supply chain issues mean that data center operators will have to factor in the lengthened timeline into their construction schedules. As we have seen, there’s tremendous demand for data center services, and the supply chain will likely delay the ability to offer new services for a period of time.” 

Power shortages will create headaches for developers and operators beyond Virginia.

Power constraints and uncertainty about future power availability will become increasingly common in major data center markets, experts predict, creating problems for developers and forcing providers to squeeze more capacity out of existing facilities. 

When Dominion Energy revealed in July that it would not be able to deliver power as promised to a number of planned developments in Virginia’s Loudoun County, it was a shock to the system for the data center industry. But insiders say uncertainty around the availability of power at potential development sites will become far more widespread in 2023, affecting markets beyond famously constrained hubs like Virginia and the Bay Area. 

Many attribute the issue to utilities failing to anticipate demand from data centers in growing industry hubs and model whether their transmission infrastructure will be able to handle these expected loads. Now, utilities are hesitant to overcommit, and that is creating chaos for developers trying to get deals done.

“Power availability is more than just a Dominion and Silicon Valley Power problem,” Seyfarth Shaw’s Rechtin said. “It’s getting harder to pin down utilities on major deployments, which will make the development cycle more tricky because the utilities won’t overcommit. In years past it was not much of an issue but is becoming one fast. It’s making deals more uncertain, even in pro-business places like Texas.”

With uncertainty around power availability limiting development in key markets, insiders tell Bisnow that 2023 will see data center operators getting creative to get more capacity out of their existing facilities. Typically, data centers use between 40% and 60% of the power allotted to them by utilities, and experts say the coming year will see data center providers working with tenants to find ways to put every last megawatt and square foot to use. 

“There’s going to be a lot of pressure developing to achieve higher usage, and to basically require customers to use what they are purchasing,” said Jeffrey Moerdler, a longtime data center and telecom attorney and member at Mintz. “Because even if a 10-megawatt data center only uses half of it, the local utility still has allocated all that power and reserved it in their generation facilities and transmission lines.”

Experts Predict Development Slowdown, More Power Problems

Development in smaller markets will accelerate as the industry spreads away from its primary hubs.

New development will accelerate in smaller data center markets, even as it decelerates in traditional hubs like Northern Virginia, experts say. 

Power constraints are a major factor in this geographic shift, as developers prioritize reliable access to inexpensive power in their site selection criteria over other factors like network strength. But insiders say this shift would be happening to some degree even without concerns over power, with hyperscale tenants increasingly interested in major deployments in secondary and tertiary markets — from emerging hubs like Phoenix to relative outposts like Utah and Nevada. 

The emergence of technologies like artificial intelligence and virtual reality are also creating demand cases in smaller markets, along with tenants looking to increase the redundancy and geographic diversity of their infrastructure to avoid outages. Lower development costs don’t hurt either.

“Northern Virginia will slow down as more companies are pivoting elsewhere and developers are building speculatively in these new markets because they are lower cost and they know demand will come,” Seyfarth Shaw’s Rechtin said. “I’m working for a few developers who are kicking off projects with medium-sized hyperscale deployments only to have other hyperscalers drop massive deployments in their laps for the same projects. Some of these developers are way below the radar but will make a huge splash in 2023 and seemingly come out of nowhere.”

Capital Markets: More consolidation and the emergence of ‘vulture buying.’

Merger and acquisition activity will remain robust across the data center sector, experts predict, while acquisitions of individual assets will shift away from stable, fully leased facilities to value-add and distressed opportunities.

“Consolidation in the data center space will continue,” said Jake Cummins, partner and managing director at data center provider UPSTACK. “Expect to see some small regional players get acquired by larger entities and private equity to continue to see value in the data center market.”

There is broad consensus that the coming year will continue to see data center platform companies with well-capitalized equity partners snap up smaller operators. Insiders say high interest rates have pushed some potential competitors out of the market and brought valuations down to earth, so those with cash in hand are likely eager to start making deals. 

“I think we’re going to continue to see more M&A in the data center space, particularly with what’s going on in the equities markets and with interest rates,” Mintz’s Moerdler said. “As people get more realistic on pricing, those that have the cash are going to be on buying sprees — so the big guy might get bigger.”

Higher interest rates and economic headwinds are also changing the math when it comes to transactions of individual data center assets, according to Ali Greenwood, executive director of Cushman & Wakefield’s Global Data Center Advisory Group. She said fully leased data centers or portfolios coming to market for disposition — investments with little short-term risk but low overall yields — will have challenges finding buyers due to the high cost of capital. 

On the other hand, Greenwood predicts that value-add data center assets on sites with access to power in tight markets will be in demand for companies that need to bring more inventory online quickly. Such sites include everything from partially built or underutilized enterprise and colocation data centers to industrial shells that can be converted for digital infrastructure. 

Seyfarth Shaw’s Rechtin also sees cash-flush industry giants turning their attention to more opportunistic acquisitions. 

“I’m seeing savvy strategic buyers with capital using the market woes and high interest rates to buy assets that are treading water or are distressed with an eye towards adding value over the mid-to-longer term,” he said. “Data centers have not seen much vulture buying but will in 2023.”

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