Determining The Value Of Data Center Sites Has Never Been Harder, Raising Risk Developers Can 'Get Burned'

Power shortages are making it more difficult than ever to accurately value potential data center sites, creating significant risk for developers as they scramble for the land needed to meet a record wave of demand. 

Speed to market is everything for the third-party data center firms purchasing thousands of acres in the hopes of leasing buildings or entire campuses to companies like Amazon Web Services, Microsoft and Google. The world’s largest tech companies, locked in an AI arms race, need more data centers and they need them now, snapping up new data center capacity as fast as it can be built and preleasing planned inventory before construction even begins. 

These tech giants insist that developers deliver expected capacity on tight deadlines. Yet over the past year, unanticipated power constraints in most major U.S. data center markets are delaying grid connections and making it increasingly challenging for developers to determine how quickly new inventory can be brought to market on a given site.

This unpredictability around speed to market has made determining the value of potential development parcels far more difficult, dramatically elevating the risk that firms overspend on land that languished undeveloped for far longer than anticipated. 

The data center industry may be experiencing an unprecedented building boom, but industry executives — speaking at Bisnow’s DICE: South event this month at the Westin Galleria Dallas — said the ability to accurately assess speed to market and limit risk exposure will separate the winners and losers in the ongoing data center land rush.  

“The capital markets, the real estate markets, private equity, there’s 800 shades of opportunity to invest in development, and people are going to get burned if they don’t do things the right way,” Primary Digital Infrastructure President Dave Ferdman, previously a co-founder of CyrusOne, said at the event.

“I think there's a lot of real estate investors that are going to get burned.”

As the AI-driven data center arms race drives up power demand beyond what utilities anticipated and strains regional transmission grids, there is almost no land left in desirable data center markets with immediate access to the massive amounts of electricity that data centers need. The rare sites where power can be delivered immediately lead to Big Tech bidding wars and fetch huge valuations. But in the vast majority of cases, third-party developers are now acquiring land that may not have a sufficient grid connection today, but where they believe power will be delivered in the near-term future. 

For the largest data center developers, who are spending billions land banking in key data center markets to try to keep pace with Big Tech demand, this isn't a completely speculative endeavor. Valuations of potential data center sites are largely tied to the clarity of a site's pathway to power, and developers are willing to shell out significantly more when utilities have committed to providing the required power within a set time frame, particularly as Big Tech tenants now routinely prelease data center capacity before these land deals even close.

With wait times for new grid connections now north of two years, and as much as seven years in some markets, development sites that can be connected faster drive higher valuations.  

But understanding and predicting how quickly a potential data center development site can get power has become far more difficult over the past twelve months, experts say. 

Until recently, a “will-serve” letter from a utility, a document committing to a grid connection and a set amount of power within a set time frame, was effectively treated like a contract by data center developers, investors and tenants. If a utility said a site would get power in 18 months, it would get power in 18 months. These utility commitments were enough for lenders to underwrite projects and for tenants to prelease the capacity set to be built on the site. 

Now, however, utilities have begun to routinely push back the delivery timelines promised in these initial power agreements. As power providers scramble to upgrade their infrastructure to meet an unanticipated wave of energy demand from data centers, they can no longer rely on the scheduled delivery dates provided by utilities, Ferdman and other executives said at DICE: South.

For developers rushing to secure buildable sites, this emerging unreliability adds significant risk to each of these transactions. Paying higher prices based solely on a utility promising a quick timeline may well be a significant mistake.

“We're at a point where a major developer has a high probability of getting a call or a Dear John letter saying: ‘We're sorry, you're not getting 40 megawatts next year, you're getting two,’” Ferdman said. “The probability of delivery of power is getting less and less, so who's going to close on land unless you know that the power is there?”

This uncertainty around access to power isn’t the only trend making speed-to-market increasingly unpredictable, as well as making proper site valuations a more murky endeavor and adding significant risk for developers.

Along with factors like ongoing supply chain delays and construction labor shortages, panelists at DICE: South pointed to community opposition and a hostile political landscape in a growing number of industry hubs. Timelines around permitting and entitlements are becoming less predictable, with local pushback potentially delaying or derailing projects.   

“Power is the biggest thing here. But when we're looking at zoning entitlements or when we're looking at easements, those can also add lead time,” said Elizabeth Yaeger, a data center attorney and shareholder at Greenberg Traurig. “Those risks need to be mitigated contractually and built into the time frames that you're promising.”

While the growing challenge of accurately gauging speed to market means developers increasingly risk buying sites that may never produce the expected return, it is also increasing the amount of capital developers have to sink into a site both before and after the actual land purchase, said Rafal Rak, vice-president for portfolio management at Digital Realty.

Prior to acquiring a potential data center site, developers must now devote far more time, man power and money to the due diligence and analysis now required to understand local and regional grid infrastructure and accurately evaluate energy delivery timelines. Understanding the political landscape and identifying potential risks to permitting or entitlement in advance also requires more effort than ever before.

Once a site is under contract, developers are now routinely making significant upfront investments to help ensure that the site has access to power as quickly as possible. In some cases, this means building on-site power generation, which may not produce all the electricity tenants will eventually need but can serve as a bridge until the site can be served by a utility. More frequently, developers are partnering with utilities to speed up delivery times by building substations or other needed transmission infrastructure themselves. 

“You have to really get proactive and do a lot of the preliminary site work to get the power more established and firmed up and committed, and that means a lot more [capital expenditure] upfront,” Rak said. “A lot of us don't like to spend speculatively without some sort of a commitment on the provider side, but we’re starting to see that becoming more of a reality. You can't just buy a site and think you're going to be able to successfully lease that up without doing that.”

While increasingly unpredictable power timelines and speed to market have made acquisitions of developable land more of a gamble than in the past, the success or failure of developers’ land banking strategy won’t come down to luck, executives said at DICE: South. 

The odds, they say, favor established players with long track records and utility-level understandings of grid infrastructure, operations and demand. Successful firms will also be able to leverage close relationships with utilities, allowing them to better anticipate potential delays and work proactively to mitigate them. Executing projects will often require the sophistication, and capital, to successfully finance and execute on-site generation if necessary. 

Developers are also starting to structure land deals in ways that mitigate their risk or push it to the prior landowner, a practice that will be critical for successful land strategies as power delivery becomes even less reliable, said Jeffrey Moerdler, a longtime data center attorney and member at Mintz. 

“You can price the land with an earn-out, where you pay a certain price per acre at closing, and then if and when you get the power the seller gets a post-closing bonus,” he said. “I've done multiple deals like that.”

With data centers outperforming other asset classes and a flood of capital looking for opportunities to deploy in the sector, developers from other areas of CRE are looking to pivot toward digital infrastructure, snapping up land and requesting grid connections with plans to develop these sites as data center campuses. But many of these new entrants may be in over their heads, DICE panelists said, stuck with overpriced parcels that may not get power fast enough to catch the unprecedented data center demand wave before it crashes.

“Way back in the day, everybody with an old Walmart was certain they had the next data center, and our phones blew up every day that some Kmart closed,” Ferdman said. “Zero percent of those turned into data centers, and lots of capital was lost. In today's world, I think this is where a lot of money is going to be lost.”