New Real Estate Strategies Help Cloud Builders Grow Faster

May 11, 2018
Real estate lease structures are playing a larger role in the growth of cloud computing, as seen in two recent deals that have helped hyperscale tenants provision space faster and secure capacity for growth.

Real estate lease structures may not seem like sexy technology, but they are playing a key role in the growth of cloud computing. Cloud builders seeking data center space are increasingly teaming with developers on sophisticated deals to accelerate their expansion.

Two recent transactions in Northern Virginia illustrate how the appetite for cloud capacity is changing the market. Developers Digital Realty and QTS Data Centers have each used a hybrid lease structure to allow hyperscale customers to reserve huge buildings that are pre-wired with power and fiber, and then gradually build out finished data center space.

This approach combines two approaches to data center leasing, enabling cloud builders to secure expansion space in strategic markets, while deploying capital on a pay-as-you-go-basis.

These deals are the latest expression of a larger trend – data center developers are working closely with their largest customers, streamlining construction to build bigger and faster, while refining lease structures to manage demand, cost and risk.

“The top five cloud service providers and other hyperscalers are seeing a long-term growth trend in their business,” said Andrew Power, the Chief Financial Officer of Digital Realty. “They’re looking to lock up capacity in large quantities of space, knowing that they’ll grow into it over time.”

Solving A Hard Problem: Cloud Capacity Planning

The big picture: Cloud computing is a large business that is growing insanely fast. Those top five players – Google, Microsoft, Amazon, Apple and Facebook – invested roughly $15 billion in capital expenditures in the fourth quarter of 2017, most of which went for data center infrastructure to support cloud growth.

Synergy Research Group estimates that cloud services grew 44 percent in 2017, with the pace accelerating to 51 percent in the first quarter of 2018.

All this cloud computing growth requires data centers to house servers and storage equipment. Data centers are expensive buildings, with extensive power and cooling equipment, and historically have required long lead time to complete.

That’s why estimating future demand for data center capacity is one of the most difficult challenges facing IT users. Users want space to grow, but it can be extremely expensive to build data centers, so no one wants to pay for unused space. In a highly competitive cloud market, no one wants their growth to be slowed by a shortage of data centers to house new customers.

At Data Center Frontier, we’ve been closely tracking the industry’s efforts to accelerate the delivery of new data centers, using supply chain improvements and larger data halls to meet customer demand for cloud capacity.

Combining Shell and Turn-Key Components

Leasing strategies are also becoming tools to win hyperscale deals. The recent hybrid deals in Northern Virginia combine two ways of leasing data center space:

  • Powered Shells: Finished buildings with undeveloped space inside, with the power and fiber connectivity already in place. These are typically leased by large users, who then build out the data center space themselves.
  • Turn-Key Data Centers: Suites of completed data center space, typically with a raised-floor and infrastructure for power and cooling for the room.

In March, QTS Data Centers announced that it had leased an entire 24-megawatt powered shell in Manassas, Virginia to an unnamed cloud service provider, which also leased an initial 5 megawatt turn-key data suite within the building. QTS said that it expects the customer to add turn-key leases that will take up the entire shell within a two-year period.

“We believe the structure of this agreement illustrates QTS’ focus on capital efficiency,” said Chad Williams, the chairman and CEO of QTS. “By leasing the full powered shell on day one, we were able to avoid having stranded capital in the facility. Due to the growth plan for the customer, which is spread over a two-year period, the relatively modest initial capital outlay for this project doesn’t affect our 2018 CapEx guidance.”

In April, Digital Realty confirmed that it had signed a lease with a single tenant for an entire 36-megawatt powered shell building in Ashburn, Virginia. The tenant will lease six megawatts of turn-key space within the building, with the expectation that they will subsequently lease additional turn-key suites in phases until the building is full.

Calculating the Cost of Opportunity

This deal structure combines elements of build-to-suit projects and speculative builds. By leasing the powered shell, the tenant gets to control the entire building, and doesn’t have to worry that it will be leased to competitors. It also makes it easy to add capacity quickly, as the landlord can build new phases as the tenant needs the capacity – rather than when space is available on the developer’s next building or campus.

The economics of these deals are tied to the different lease rates for the two products. In the first quarter, Digital Realty leased its powered shell space for an average of $24 per square foot, compared to $163 a square foot for its turn-key data center space.

An example of a turn-key data hall inside a QTS Data Centers facility in Richmond. (Photo: Rich Miller)

“What we love about that structure, which is fairly unique, is that it’s easy to drive capital efficiency,” said Jeff Berson, the Chief Financial Officer of QTS. “We didn’t trap capital in a powered shell where we’re not getting a return, which typically would happen in those types of structures. We are getting a return.

“But on top of that, we didn’t build out 24 megawatts (as turn-key),” Berson added. “We were able to just put significant capital to the first five megawatts. It also provides the visibility that will ramp over the next couple of years, with a customer taking additional megawatts every couple of quarters.”

‘Customers Want Runway’

The practice of allowing tenants to pay a fee to reserve space is not new, as contracts have long allowed for options on adjacent space or additional capacity. This was a particular emphasis of Aligned Energy when it entered the data center market in 2015, offering packages that allowed tenants to reserve expansion space within the same data hall.

The energetic pace of cloud growth has led tenants and developers to super-size the process, reserving entire buildings for future growth.

“I think that many of our large and growing customers are thinking long-term about the growth in their business, and this is just one way to tackle it,” said Power of Digital Realty.

An example of powered shell space in a Dallas facility. (Photo: Rich Miller)

It’s not surprising that this strategy has featured in large deals in Northern Virginia, which is the largest, most active and most competitive data center market in the world. But this isn’t a case of an altered reality that exists only in Ashburn’s “Data Center Alley.”

“There’s no question that the deals are getting bigger,” said Kevin Timmons, Chief Technology Officer at CyrusOne, which has been a pioneer in delivering cloud space quickly. “Customers are getting more sophisticated, and customers want runway. This isn’t necessarily a Northern Virginia thing.”

Matching the Deal Structure to the Market

In fact, CyrusOne CEO Gary Wojtaszek said this type of lease structure required discipline in competitive markets, and must be viewed in the context of supply and demand in each geographic region.

“We’re not interested in tying up a lot of valuable real estate in a market where we’re doing really well,” Wojtaszek said on the company’s earnings call. “We make significantly better returns on doing fit-outs on a complete building, and wouldn’t want to give up a lot of capacity in a market where we’re running tight. If it’s Atlanta or Quincy, that’s something that we would definitely consider doing there because we have nothing currently, and that’s an easy way to get in. So it’s all dependent on the customer, what they want and our available inventory and how we think about that.”

That was a factor for QTS, which used the Manassas contract to secure a 66-acre site that can support a large, multi-building campus..

“We have tremendous access to power and fiber there in Manassas,” said Williams. “The thought that we could have a hybrid colocation building to drive that campus to higher returns is very, very possible in the future.”

About the Author

Rich Miller

I write about the places where the Internet lives, telling the story of data centers and the people who build them. I founded Data Center Knowledge, the data center industry's leading news site. Now I'm exploring the future of cloud computing at Data Center Frontier.

Sponsored Recommendations

NECA Manual of Labor Rates Chart

See how Champion Fiberglass compares to PVC, GRC and PVC-coated steel in installation.

Electrical Conduit Cost Savings: A Must-Have Guide for Engineers & Contractors

To help identify cost savings that don’t cut corners on quality, Champion Fiberglass developed a free resource for engineers and contractors.

Conduit Sweeps and Elbows for Data Centers and Utilities

Data Centers and Utilities projects require a large number of electrical conduit sweeps and elbows. Learn why Champion Fiberglass is the best supplier for these projects.

Prefabricated Conduit Duct Banks Enable Smooth and Safe Electrical Installation for a Data Center

Prefabricated conduit duct banks encourage a smooth, safe electrical conduit installation for a data center.

Image generated by Midjourney, courtesy of EdgeConneX
Image generated by Midjourney, courtesy of EdgeConneX

Future-Proofing AI: A Blueprint for Success

Phillip Marangella, Chief Marketing and Product Officer for EdgeConnex, describes what a smart, forward-looking data center platform needs to deliver for AI and other HPC customers...

White Papers

Get the full report.

The IT Leader’s Ultimate Guide to Building a Disaster Recovery Strategy

Aug. 10, 2022
In this white paper, Flexential outlines five basic steps for creating a robust, reliable and tested disaster recovery plan that’s tailored to your business.