Data Centers vs CRE: Investors Like Data Centers Because of Long-term Prize and Contracts, But You Need the Right Revenue Model and Mgmt Team
by Josh Anderson
DENVER, CO — CapRE’s Second Annual Greater Denver Data Summit kicked off with a deep dive into the Denver market, Greater Denver & Colorado Data Center Market 360: New Product Lines in 2018 and Analysis of the Developer, Investor and Capital Sources. About halfway through the panel, Moderator Doug Corsmeier, Vice President at Winthrop Resources, Moderator the day’s first panel asked panelist Todd Coleman, President and CEO of Estruxture Data Centers to talk about what sets apart data center investment from other types of investment.
“There are two types of investors. And for those that are real estate investors in the room, I apologize, but a data center is an operating business. It’s not a real estate business,” Coleman asserted. “I think we are tangentially related to real estate. And I think real estate investors have made that mistake in the past, they look at it and say, wow, instead of doing a 4 cap or 5 cap, I love the returns of the data center business, but we’re EBITDA driven. We’re not cap rate driven.”
“And you find yourself having to ask, how do I operate this thing? Who am I selling to? Why are they buying from me?” listed Coleman. “Those are fundamentally different questions from the real estate business. There are folks like Carter Validus that are getting great returns, but those are more sale-leaseback type of transactions, where they have a long-term enterprise tenant in there.”
“If you get into the colocation business, whether it’s retail or wholesale, and you think that’s more of a real estate transaction and you don’t have the operate to operate and have a value proposition, then I think that’s more of an intelligent investment,” he continued. “Why do investors like it? Look, it’s a return-driven model. As soon as you understand EBITDA, you love the model, and you love the multiple. I think that has attracted a lot of money that still sits on the sidelines today. Because the love for the returns? Well geez, I can go out and do a 40% IRR and get that kind of return over five or six years, but then they lose site of the capital intensity.”
“You know, we manufacture widgets. Those widgets are in the form of space and power. And we manufacture solely for the facility, and then you have to roll that back in and re-invest,” shared Coleman. “So if you don’t have a solid balance sheet, a long-term investor view, and the willingness to roll back your profits into the capex, and then some, then I think it’s a struggle. From that perspective, obviously, there are all sorts of different debt models out there. But if you’re truly invested, and you’re looking for a true operating business, then it’s a phenomenal business…it de-levers extraordinarily quickly.”
In Coleman’s view the investors like it because of the long-term investment prize and solid contracts. “And look, if you’re an operator, it’s fun because we can tell who has invested in the data center business and who hasn’t, based on the type of questions we get when they’re talking about investing,” he revealed. “One of the questions we get is, what’s your DSO in accounts receivable? What balance do you carry? The answer is, we don’t carry much because the threat of flipping the switch is significant.”
“If you’re late, if you’re delayed, and we’re sending letters, someone is going to walk over to the RPP and threaten to switch off a breaker, and guess what, the money is going to show up in your bank account,” Coleman chuckled. “It doesn’t happen always but it happens about 98% of the time. So there are fundamentals about the data center and it ultimately comes down to, you can look at it from the investment horizon, but most of those investors…they like the asset class, they like the returns, but if you don’t have the right revenue model and the right management team, then you truly are investing in real estate, and that might be problematic for you down the road.”
For more from this panel, check out previous CapRE Insider Reports:
- Denver Data Center Market 360: Evolving, But Under-Rated Arena Could “Go Through the Roof”
- Will Denver’s Data Centers Lead the Edge Markets?