Data Center Market Will Tighten When Investors Become More Comfortable with Asset Class

Oct 9, 2017
by Josh Anderson

CHICAGO, IL – There are a lot of facets to the Flight to Cloud, especially when thinking about the future and its potential. We’ve written a lot about the Flight to cloud may not be a one-way flight after all, but more of a road trip with many detours, but we haven’t yet touched on one interesting aspect — what does the Flight to Cloud mean from a rent or revenue perspective? This is the second piece in a two-part article about a panel discussion we heard between Jonathan Schildkraut, Chief Strategy Officer, CyrusOne and Eli Scher, Chairman and CEO, New Continuum (check out the first article for the bigger picture). 

When Schildkraut thinks about prices, he always says that it’s the toughest question out there. “I think that it can be misleading, because ultimately pricing is sort of the return that we demand to build out an asset for someone else,” he says. “And that return is going to vary depending on the commitment that the customer makes to us, the amount of capital we have to put down, and the risk of that customer itself. So what I would say is that we continue to be amongst the real estate classes out there, demonstrating the very highest returns among our peers. That tells you that, whatever is happening, we’re all still very good stewards of capital, which I think is incredibly important.”

 Next, Eli Scher, Chairman and CEO, New Continuum continued on this rain of thought. “The flipside to that is that more people need to get more comfortable with the asset class, and it will tighten,” he predicts. “Then the yield and the command will come down. I think that will ultimately happen, and it’s starting to happen. Because all of the data center REITS perform really well. They return really well. Why should they trade at a spread to a commercial REIT?”

 “Why is a Microsoft lease at a data center less a valuable than a Microsoft lease in an office?” Scher asks. “It is still today. So I think that will ultimately change. And like Jonathan said, it’s the risk you’re willing to accept. Because this is Microsoft after all. It’s a triple A credit. You’ll take it all day long, and you’ll put capital out on that basis.

Schildkraut agrees with Scher’s thinking, but does point out one important fact. “Data centers as a real estate asset class trade at a discount to the other average of other real estate asset classes,” he says. “But to that point, can 15-18% be sustainable? If you believe that, then you’re really misleading yourself. Over time. Most returns will be depressed, but you’ll still see a higher return than other real estate asset classes, simply because we are carrying more risk. You have to adjust for risk.”

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