Among the parts of Asia’s commercial property investment market that have attracted increasing interest over the past several years are “alternative” sectors. These are the non-traditional types of real estate, such as
education, senior living and self-storage facilities. Benefiting from secular trends in the region’s economies, and offering higher rates of return, alternatives have proved increasingly popular among investors.
Yet, since the Covid-19 pandemic struck, one sector has stood head and shoulders above the rest in terms of its performance and appeal: data centres. The virus-induced acceleration in the shift to digital work and play from home has proved a boon for the warehouse-like facilities that power all kinds of online products and services.
In a sign of the extent to which sentiment towards data centres has been more upbeat than in other property sectors, the share price of Equinix, the world’s largest data centre real estate investment trust (Reit) by market capitalisation, rose 22 per cent last year. By contrast, an S&P 500 index of office-focused Reits fell by the same amount, with retail and hotel-focused Reits faring even worse.
In the Asia-Pacific region, while commercial property transaction volumes plummeted in 2020, investment in the data centre market surged to US$2.2 billion, up from just over US$500 million in 2019, according to a report published by CBRE on March 25.
While the sharp rise in transactions was part of a bigger push into alternatives, data centres have hit a sweet spot for investors. At a time when leasing activity across the region has suffered due to the pandemic, net absorption of space and power at co-location data centres tracked by CBRE in the developed markets of Tokyo, Sydney, Singapore and Hong Kong rose 124 per cent last year to a record high. Most of the demand, moreover, came from large cloud service providers that operate hyperscale facilities.
Not only have the fundamentals of data centres strengthened further during the pandemic, the sector provides the best of both worlds. While data centres have emerged as one of the most defensive property assets – their tenants have strong credit ratings and tend to stay put due to relatively high switching costs – the industry benefits from transformative megatrends that have been turbocharged by Covid-19.
A sector that was a niche market prior to the pandemic has been catapulted into the premier league of Asia’s commercial real estate investment market, underpinned by a flurry of capital raising, joint ventures and platform deals. “All the [recent] activity tells us that as an asset class, data centres are undeniably mainstream,” says Bob Tan, director of alternatives for Asia at JLL.
Still, for a sector that plays such a critical role in the post-Covid-19 economy, and is attracting such strong interest, the barriers to entry, or hurdles to investment, are remarkably high. Difficulties in deploying capital stem mainly from a sharp disconnect between the weight of money targeting data centres and the expertise and risk tolerance required to establish a presence in the sector.
For starters, data centres are quite distinct from the most common types of commercial real estate, such as office buildings and shopping centres. A critical part of the digital infrastructure that connects people and businesses to one another and the rest of the world, data centres are a unique combination of property, energy and technology.
Second, the importance of the operational aspects of running the facilities means that investors and developers must contend with thorny regulatory issues, made more challenging by different regimes and levels of market maturity across Asia.
A particularly sensitive area is nations’ data localisation laws that require information to be held in servers inside individual countries. At a time when data protection is a hot-button topic, and when the trade war has heightened concerns over cybersecurity and industrial espionage, investors focused on data centres need to navigate these issues carefully.
Another major challenge is access to cheap, reliable power, especially since electricity is often the biggest cost of running a data centre. An equally important consideration, particularly given the pandemic-induced surge in demand, is sustainability.
While Singapore was ranked the second-most attractive country for data centre investment after America, according to a report published by consultant Arcadis last month, it is also one of several cities in Asia that has imposed curbs on new power provisions for data centres to help reduce carbon emissions.
For many property investors, all these hurdles are off-putting. But for those able and willing to take on development risk, or team up with experienced operators, there are significant opportunities to gain exposure to the sector, notably in some of the less-developed markets, such as India and Indonesia.
Mark Smith, managing director for Asia-Pacific at Digital Realty, one of the leading global data centre operators, says data centres are a highly complex part of industrial property. Yet, he also says the pandemic has shown how indispensable digital infrastructure is to the global economy. “Our pedigree is real estate, but the future is technology,” he says.
Few property investors would disagree. However, while data centres may be all the rage, deploying capital in the sector, and achieving the necessary scale to serve regional and global customers, are easier said than done.