(Photo by Sean Gallup/Getty Images)

(Photo by Sean Gallup/Getty Images)

Data Center Colocation in 2016: What to Expect

Edge data center users and companies with Internet of Things applications may breathe new life into secondary data center colocation markets in 2016. However, when it comes to large-footprint deployments, it appears 2016 will unfold in a similar manner to last year.

That’s according to Bo Bond, a managing director at the commercial real estate firm Jones Lang LaSalle. JLL recently released its Winter 2016 North America Data Center Perspective report, which examines the leasing activity and sale-leasebacks by data center providers.

Customers are Getting Savvier

Corporate customers are increasing looking to outsource hosting of day-to-day applications, such as email, accounting, and customer service, usually to cut cost or to free up capital for core business initiatives. Savvy corporate clients also realize that they can offload risk through Service Level Agreements with a major data center provider, Bond said.

But enterprise interest in data center colocation for core business and high-performance applications is growing too. These often require sophisticated connectivity and hybrid cloud IT architecture.

Read more: Digital Realty Leans on IBM, AT&T to Hook Enterprises on Hybrid Cloud

Tenants are also concerned about the rampant M&A activity in the data center provider space. In certain situations clients are insisting on lease clauses providing for an option to terminate the lease if the facility is purchased by certain competitors. In other cases, there are requests for non-compete clauses or exclusive rights to provide a service.

It’s Not Just about Cost

Increasingly, the ability for a data center colocation provider to offer flexibility to expand or reduce square footage, increase power density, or add more services is a priority for tenants. While location and price are still important, flexibility is now almost always a top-three consideration for clients, Bond said.

Read more: Modular Cooling System Enables on-Demand Data Center Capacity

In fact, flexibility in the lease contract and the SLA can be more important than price for many customers.

Tenants are Sticky

In situations where there has been a good working relationship, tenants are generally inclined to renegotiate a lease renewal or extension with their current landlord. Landlord brand equity in the marketplace can be a key factor initially, but, Bond emphasized, colocation data center operators shouldn’t “rest on their laurels.”

Often, the IT refresh cycle can be a catalyst for a client to relocate. It can be more efficient for tenants to move at the end of the lease, if there are acceptable alternatives in the market.

In markets like Silicon Valley, where demand is high and supply is low, landlords set the agenda. Conversely, a market like Houston is likely to see tenants with the upper hand in 2016, due to the low price of oil, and, most notably for Houston, natural gas. Bond expect to see tenants lock in some longer-term leases at attractive prices in markets with relatively little new demand.

While landlords like CyrusOne have exposure to the oil-and-gas sector, they have contracts signed with some of the most creditworthy sector stalwarts. Additionally, the data center architecture in the energy sector for large high-performance computing deployments is somewhat unique, which is another factor adding to customer stickiness.

Demand not Letting up in Top Markets

There was a tremendous amount of space absorbed in Northern Virginia during 2015. The demand for data center capacity near the big connectivity hub in Ashburn has spurred a flurry of land purchases and development activity for 2016.

Bond expects to see steady demand in Northern Virginia for 2016, which should benefit all of the larger landlords, including Digital Realty Trust, Equinix, and DuPont Fabros Technology.

Market by Market

Dallas – Legacy telecommunication, healthcare, financial services, and airline industry provide a pool of older data centers to help drive migration from customer-owned facilities to third-party landlords. Technology firms have recently started to locate in the area, adding another industry to the mix for the Dallas-Fort Worth metro area.

CyrusOne has a long history in Dallas and a “home court” advantage. QTS is now active in the marketplace with a massive campus. Digital Realty and RagingWire are both “moving dirt,” which will add to customer choice for large MW deployments, according to Bond.

Read more: RagingWire Takes its Massive-Scale, Luxury-Amenities Data Center Model to Texas

Dallas-based Bond is bullish on the data center colocation prospects for the market, citing an overall business-friendly climate in Texas as one of the reasons more corporations are relocation regional headquarters there.

Chicago – Bond is bullish on the Chicago market for 2016 and beyond. He views the market as “healthy” and sees substantial demand for the new supply being constructed by Digital Realty, DuPont Fabros, and QTS. He pointed out that the former Chicago Sun-Times property being developed by QTS will offer a new location for customers to consider between downtown and the suburbs.

Atlanta – Considered a tier-two market, Atlanta is likely to see significant growth in the future. There, corporations looking to locate a facility in the Southeast can “check off most of the important boxes,” such as: minimal coastal risk, existing national and regional headquarters, a major airport and airline hub, a large existing employee base, and prestigious universities.

However, Bond sees a chicken-and-egg problem when it comes to supply. QTS has been the dominant player in the market with two large facilities. Customers like to have choice when they are considering a new location. Telx has an Atlanta presence, and Bond believes that looking ahead to 2017 and 2018, if Digital Realty, Telx’s new parent company, were to choose to expand in Atlanta, there would be demand for that type of product.

Minneapolis – Bond sees Minneapolis-St. Paul as “quietly being a great market.” It is also a tier-two market, but it has not attracted much attention from the public REITs. The incumbent private data center providers, including ViaWest and IronGate, continue to knock down deals, but typically they are less than 1MW. Minneapolis is a lower-cost Midwestern alternative with plenty of land and good connectivity to Chicago, Colorado, and Dallas.

Outlook for the Usual Suspects

When it comes to the six publicly traded data center REITs allocating capital in 2016, Bond used a basketball analogy: “Why attempt a 15-foot shot, when a layup also counts as two points.”

Northern Virginia, Dallas, Chicago, and the supply-constrained Silicon Valley will remain the data center markets with the greatest demand for 2016. However, built-out capacity constraints in tier-one markets may help some of the smaller markets land a few larger deals.

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About the Author

Bill Stoller is a financial writer/analyst, seated at Wall St. & Main St. where real estate intersects trends in: technology, retailing, office/industrial, residential, healthcare, energy infrastructure & green initiatives. He covers REITs, real estate and related technology, as well as fintech and real estate crowdfunding. He has written hundreds of investing articles which can be found on Seeking Alpha, Benzinga, Motley Fool, and Investopedia, Finviz and Yahoo! Finance. He often writes about data centers REITs -- a new and growing asset class -- attempting to bridge the gap between technology & traditional REIT investors. You can follow @REalBillStoller on Twitter, Seeking Alpha (http://seekingalpha.com/author/bill-stoller) articles, Tools4Investing (https://www.facebook.com/Tools4Investingcom) on FB, LinkedIn (https://www.linkedin.com/in/realbillstoller), and Google+ (https://plus.google.com/+BillStoller/posts). Bill is a real estate veteran with over 25 years of industry experience, including: general contracting, commercial, office and industrial development. He served as Vice President - Energy Services for Mechanical Services, Inc., a leading mechanical contractor in Central and Southwest Florida, and 1997 Contracting Business magazine Commercial HVAC Contractor of the Year. MSI is now a subsidiary of EMCOR Group, Inc. a Fortune 500® leader in mechanical and electrical construction, energy infrastructure and facilities services.

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