North America represents 44 percent of the global data center market, and Northern Virginia's Data Center Alley is the region's crown jewel.
A convergence of fiber networks, undersea cables, and its many existing data centers continue to attract a disproportionately large share of all data center construction and leasing leasing activity to the area, and today, the market is only getting hotter.
Allen Tucker, managing director at the commercial real estate firm Jones Lang LaSalle, said a confluence of recent events has created a dramatic leap in leasing activity year-over-year in Northern Virginia.
On the supply side, available land with favorable zoning and entitlements, sales tax incentives at the state level, and a proactive posture by Dominion Virginia Electric have all contributed to attractive pricing and record data center leasing.
On the demand side, JLL sees expansion of cloud demand and managed services, growing at 61.3 percent and 16.6 percent annual rates, respectively, over the next five years. Across the US, Tucker foresees that newly constructed multi-tenant data center space will grow at an average 12.2 percent annually through 2018.
Northern Virginia, he believes, will remain uniquely positioned to capture its share of the leasing bounty.
Record Leasing Continues
The Northern Virginia data center market had already notched 78MW of data center space by this year's mid-point, eclipsing the record 62.2MW absorbed over the entirety of 2015, according to JLL. The average annual absorption since 2007 in NoVA has been 47MW of wholesale space, excluding power based building shells.
Fast-forward to September, and JLL pegs NoVA leasing at 105MW year-to-date, with another 40MW under negotiation and expected to be signed between now and the end of the year.
That estimate doesn't include Amazon, which takes so much data center capacity, it merits its own category. PBB, or Power Base Building space, on the absorption chart below primarily reflects Amazon's data center leasing:
Source: Allen Tucker, JLL
Amazon is responsible for about 90MW of PBB space, while the 105MW of multitenant data center capacity leased as of last month consisted of 17 transactions, including leases by Microsoft, Oracle, IBM Softlayer, Electronic Arts, World Bank, and Apple.
Tucker explained that the 40MW expected to be signed by year-end 2016 reflected budgeted IT demand, mainly from enterprise users. He expects to see a flurry of activity after the November presidential election.
Supply and Demand Remains Healthy
The overall data center market in the region is vast, with over 8.4 million square feet of data center space and 671MW of power total. However, vacancy rates remain at 5.2 percent, according to JLL.
The business-friendly environment in Virginia has attracted a bevy of publicly traded and privately owned data center operators. In addition to the "usual suspects," which Tucker described as the Big 7 REITs (the six data center REITs and Corporate Office Property Trust), favorable market dynamics have attracted plenty of other large players:
Source: Jones Lang LaSalle - Allen Tucker
It's worth noting that some analysts do include Iron Mountain among the big data center REITs, but the company's business is much more diversified than its rivals in the data center market.
Northern Virginia's electric utility, Dominion Virginia Power, continues to make significant investments in infrastructure to provide substations, transmission lines, and a robust infrastructure design, while actually lowering the rate that it charges large data center customers.
The current $0.52 per kWh rate in NoVA ranks it as one of the lowest-cost utility markets in the US. It is 40 percent lower than the $0.87 per kWh national average for the largest data center markets.
These rates, combined with sales tax incentives for data center equipment at the state level, make the total cost of ownership for data centers in Northern Virginia quite compelling for large compute and storage customers.
The Virginia sales-tax exemption program originally became effective in 2012 and was originally scheduled to expire in 2020. In March 2016, the state legislature granted a 15-year extension, which prolonged the program until 2035.
While economic development officials often support data center projects, since they create substantial and steady tax revenue streams without placing much stress on municipal infrastructure and services, not all residents in Virginia are happy about the data center boom.
The conundrum facing investors and management teams is trying to determine what the "new normal" will be for leasing demand in Northern Virginia. Tucker referred to the current leasing barrage in 2016 as being a "Mickey Mantle" year.
In addition to regional and international connectivity, this market has an economic advantage over New York and Northern New Jersey when it comes to attracting large-scale financial sector deployments and has a large defense and contractor component. However, it appears that monitoring the demand by the hyperscale cloud providers in 2017 and beyond will be essential for investors trying to model earnings growth of the publicly traded REITs.
Discussions by REIT management on upcoming Q3 2016 earnings calls are likely to provide the best opportunity for investors to glean information regarding their leasing pipeline.