Data centers used to be a niche property in CMBS, but with the rise of new technologies, it is becoming one of the few areas in a declining commercial real estate market that still offers stable performance and attractive returns.
However, recent deals have shown that issuers will have to hold their deals to higher ESG standards if they want prolonged success in the securitization market from the caliber of investors they need to succeed.
In the market for data centers, demand has been outpacing supply in recent years. The amount of data created and consumed is expected to grow sharply from 101.3 zettabytes in 2022, to 221.2 zettabytes in 2026. And this has translated into the securitization market. Deals backed by data centers have surpassed $3bn so far this year, twice as much as in 2022, around 10% of all US CMBS activity.
However, despite the fast growth, there is a reputational risk from data centers. In order to keep up with the demand from AI and cloud computing, data centers use an incredible amount of energy. They are in fact one of the most energy-intensive building types, consuming 10 to 50 times the energy per floor space of a typical commercial office building. Collectively, these spaces account for approximately 2% of total US electricity use.
One of the most prominent examples is Amazon, which is currently building a huge “data center valley” in Northern Virginia that will likely boast the energy consumption of a small city once complete. And existing properties are no better. As of 2022, Northern Virginia alone contained over 2,000 megawatts of capacity across more than 12m square feet.
This consumption is something that big investment firms simply cannot ignore. Even with the recent backlashes against ESG in parts of the US, most of the large investment firms are still climate conscious and have a large amount of investment committed to ESG strategies.
Blackrock, for example, which manages $7.96tr, has a total of $475bn invested in dedicated sustainable or ESG strategies across the company's actively and passively managed investment portfolios. Across the country, sustainable assets have doubled over the past three years, reaching $255bn at the end of last year.
More importantly, despite murky regulations and an arguably pay-to-play ratings market in the US, big investors still seem more willing to invest in bonds that carry an ESG label.
The recent deal from Digital Realty Trust for example, DC 2023-DC, is one of the first to be backed by data centers that was certified as a green bond. Thanks to its green bond status it attracted more big name investors with ESG mandates, and was four times subscribed in almost all tranches, landing at tighter spreads than almost all of the other data center deals this year.
Another deal from Blackstone, BX 2023-VLT2, on the other hand, which was not given the same green credentials, landed 45bp wider in the AAA tranche. The bottom tranches were even priced wider than guidance, despite having a bigger and more experienced sponsor. The disparity here shows that in data center CMBS, at least, the greenium exists.
But in the world of data centers; returns and performance aren’t everything. If issuers want the asset class to grow faster and attract big investors, they must make sure the deals come with high ESG standards. Otherwise, larger investors be forced to take a pass on one of the few good asset classes left in a weak CRE market.