Chicago Insiders Discuss: What is the Expected Expense Ratio in a Turn-Key, Gross Lease?
by Josh Anderson
CHICAGO, IL – Financing a data center is no easy task. And neither is the decision-making process that a lender must undertake when deciding whether and how to make a go of it. At CapRE’s Seventh Annual Chicago & Midwest Data Center Summit, we convened a panel of leading insiders from the regional capital markets arena to discuss this thought process, on a panel titled Capital Markets Takeaway: What Types of Debt and Equity Sources will Become More Active in 2018? Below we highlight some of the thoughts offered from the panelists in response to a question from the audience.
Audience Question: When it comes to turn-key data centers, on a lease with gross lease rents, where the landlord is picking up the tab on all of the expenses, I’m just wondering, when you’re coming up with a cap rate for that, what expense ratio do you feel comfortable with? There is some heavy cost incurred with having engineers on-site, not to mention power and taxes. Is there any kind of range that you see?
Dave Spiewak, NextTier HD: I’m just going to make one comment, because I negotiate a lot of contracts for tenants with their providers. Every lease is different. If Digital realty Trust has a building with ten tenants in it, and everyone has a different PUE cap, that certainly affects what that revenue is. in some leases, they’re getting paid on real estate taxes with base. In others, it won’t be in there at all. And that’s just how people negotiate those contracts. So I don’t know how you can. Every lease is going to be independent.
Dan Bryson, Executive Vice President, Finance, JLL Capital Markets: There’s not a rule of thumb, like there is with the other four property types. Because there are so many [variables]. How much of the income is managed services, for example? And then you look at the contract and the SLAs, and some SLAs are just not financeable. Some lease termination rights are not financeable. It’s not a broad stroke like you’ve got a 2.0. when you get to a NOI, then you can pretty well size up your loan off of that. You get a 1.5 to 2.0 cover, 1.7 is probably more market. But to get to that NOI is an individual-type of process.
Mario Calderone, Vice President – Real Estate, Server Farm Realty, LLC: We see a lot of transactions, a lot of sale-leaseback type of things. And we see a lot of sort of enterprise operation expenses and other entities. So for us it’s kind of easy. That’s our business. We run all of our own infrastructure. We manage all of the infrastructure in our own properties. So we’re pretty good at operations and we’ve got that refined to a pretty good number. and man, some of the things that I see, particularly from financial institutions, it’s just — you cannot compare the two. It’s apples and oranges. What they spend on operating costs in a year, we could run our company on for many years.
Now, I will say that some of that – and this is why it’s hard to underwrite – you have to say, what am I underwriting to? So for us that’s easy, because we are underwriting to our standards. We provide an operating standard in all of our buildings. If you want something above that, then of course we can provide it. but some of the financial institutions that we are looking at, they have security requirements, for example. and they do maintenance at hours during the week that we simply wouldn’t do.
Some of them do that for a very specific, business-related reason. Security transactions, for example, if they’re a trading firm and they’re trading globally, and they can only do maintenance in two-hour windows. Saturday from 3 AM to 5 AM, something like that. You’re going to pay a fortune in operating costs. But for us, on a standard, Tier III-level type data center? On operating costs, we’ve got that down to a science. Our numbers come in at a very tight range.
Bryson: Well, when we underwrite a deal, we would look at all of that. And it depends on who their sponsor is. and their experience. And when we would present that deal to Joe, we would have some verification and justification of those OpEx, and the story behind them. So, it just depends on the deal and who the operator is.
For more from Spiewak, Calderone, Junda, Bryson, and the rest of this panel, check out previous CapRE Insider Reports covering earlier remarks:
- Dan Bryson, JLL: Data Centers are Designated Assets, Even if Lenders Don’t Like It
- What Kind of Data Centers Are Most Attractive to Lenders?
- How are Managed Services Multiples Trending Lately?
- How Have Debt Markets Changed by Accepting Data Centers as an Asset Class?
Banner Photo (L-R): Dave Spiewak, Next Tier HD & Mario Calderone, Vice President – Real Estate, Server Farm Realty, LLC