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.
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