Data centres are one of the most attractive asset classes in the country today. Many private equity investors are looking to deploy capital in this segment. This is due to a multitude of reaso­ns. The global data consumption has gro­wn manyfold in recent years. During 2021, the total data consumed globally was 79 billion TB. Of this, only 1 billion TB was stored in data centres. This gap highlights the growing need and demand for data centres as critical infrastructure.

With regard to data centre real estate in­vestment trusts (REITs), the US is the only market that has matured. During 2020, most of the asset class REITs that were listed in the US were adversely impac­ted by the pandemic. Among the few that yielded positive returns, data centres gave the highest return at 21 per cent. As the ma­­rkets recovered in 2021, all REITs gene­rated a positive return, but data centres re­mained stable with returns of nearly 25 per cent. Thus, the data centre asset class is relatively less volatile than other as­set classes. In addition, data centre REITs are constan­tly overperforming. This ma­kes them attr­a­c­tive for public and private equity investors.

Features of data centres as an asset class

  • The data centre asset class is unique as it is an amalgamation of real estate, infrastructure and technology, although with highly specialised specs.
  • This asset class has very long lease tenu­res, around 10 years, with clients. Hy­per­scale customers can execute up to even 30-year contracts. This gives more stability and visibility to investors.
  • There is an additional earning potential on interconnection, managed services, ma­naged infrastructure, etc. Thus, the ability to gain an alpha over regular re­turns is higher.
  • Customer stickiness is extremely high in the data centre asset class, not just on price but also on a bunch of critical technical criteria. This is because it is not ea­sy to migrate servers between data cen­tres, and customers would rather scale in the same data centre. This means less risk for investors.
  • There is a saturation of opportunities and co­mpressed yields in conventional re­al es­tate in certain markets. The data centre asset class allows diversification for inves­tors with its downside protection and low risk.

Investment drivers in India

The size of the data centre industry in India was $5.6 billion as of March 31, 2021, based on earnings before interest, ta­­x­es, depreciation, and amortisation (EBITDA). The segment’s overall revenue jump­ed from $385 million in 2014 to $1.2 billi­on in 2021, while the EBITDA margin im­proved from 24 per cent in 2019 to 33 per cent in 2021. Internet penetration in India stood at 45 per cent, while the country ac­counted for 14 per cent of the total mo­bile subscriptions and 15 per cent of to­tal mo­bile data traffic globally in 2021. How­ever, the number of data centres and th­eir capacity constitute only 3 per cent and 6 per cent, respectively, of the world total. This highlights a significant gap, whi­­ch has attracted investors to the data ce­ntre industry in India.

Investment trajectory

The global capital flowing into the data ce­ntre industry primarily comes from bulge-bracket private equity investors, while domestic private equity players are also gearing up to enter the fray. The year 2021 was a notable year for the industry as large joint ventures were announced. Me­an­while, hyperscalers committed to inves­ting in digital infrastructure in India. The­re has also been a shifting trend of creating platforms that are directed towards a future REIT listing.

The data centre capacity coming up until 2025 is estimated to be 1 GW. The capital required for building this capacity will be nearly $5 billion. Equity capital required will be $2 billion (assumed based on leverage margins), of which $0.5 billion is already deployed. There is a huge am­ount of capital chasing limited investment opportunities in the market. The industry is skewing towards the hyperscale and wholesale colocation market, and capital is available only for such opportunities, whi­le the risk appetite for retail colocation seems relatively low.

Risks and returns

The risks involved in the data centre asset class include:

  • Increased risk of speculative developments.
  • Interplay of real estate, infrastructure and technology needs careful evaluation in underwriting of costs, revenues and risks.
  • Land acquisition in India is complex wi­th possibilities of issues regarding title, government records and transfer app­rovals/charges.
  • Stakeholders need to factor in mitigation of risks such as technology obsolescence, automation and need for data compression.
  • Stringent service level agreements and consequences of breach can have enormous liability impacts.

Meanwhile, a 13-14 per cent develop­me­nt yield is sought by core investors and 18-22 per cent returns are sought by core and growth investors.

Based on a presentation by Devi Shankar, President, Industrial and Logistics, Data Centres, ANAROCK Capital