State of the Data Center Industry

[Pages:55]State of the Data Center Industry

An Analysis of Washington's Competitiveness In This Fast-Growing High-Tech Field

January 2018 Report to the Legislature Brian Bonlender, Director

Acknowledgements

Washington State Department of Commerce Chris Green, Assistant Director, Office of Economic Development and Competitiveness Joseph Williams, Ph.D., Governor Inslee's ICT Sector Lead/Author Moh Kilani, Lead Researcher/Writer Noreen Hoban, Project Manager, Research Services Steve Salmi, Ph.D., Editor, Research Services

Consultant on Electricity Costs Robert McCullough, Principal, McCullough Research Eric Shierman, Research Associate, McCullough Research Robby Gottesman, Research Associate, McCullough Research

Special Thanks Cody Arledge, Principal, Johnson Arledge Strategies Conan Lee, Managing Director, JLL John Sabey, President, Sabey Datacenter Properties Lisa Goodman, Vice President of Marketing, Centeris Simon Lee, Managing Director, Sapience Capital Partners

Joseph Williams, 206-256-6118, joseph.williams@commerce. Washington State Department of Commerce Office of Economic Development and Competitiveness 1011 Plum St. SE P.O. Box 42525 Olympia, WA 98504-2525 merce.

For people with disabilities, this report is available on request in other formats. To submit a request, please call 360-725-4000 (TTY 360-586-0772).

State of the Data Center Industry

Table of Contents

Executive Summary........................................................................................................................ 1 Introduction..................................................................................................................................... 3 Data Center Economics ................................................................................................................. 4 Data Center Market Trends .......................................................................................................... 11 The State of Washington Data Center Market ............................................................................ 17 Analysis......................................................................................................................................... 24 Closing Observations................................................................................................................... 27 Appendix A: Urban Competitiveness, Hillsboro vs. Seattle...................................................... 28 Appendix B: Report on Electricity Cost Comparison ................................................................ 49

State of the Data Center Industry

Executive Summary

The data center industry is experiencing explosive growth globally and nationally. Although data centers do not create many direct jobs, studies show that a vibrant data center cluster stimulates job growth in related information and communications technology (ICT) industries. This, in turn, drives significant local economic growth.

In recent years Washington has captured relatively little new business. As recently as 2011 Washington was considered the data center hub of the Pacific Northwest, but that is no longer true.

To better understand what happened, the Washington State Department of Commerce (Commerce) was directed in the 2017-19 Operating Budget (SSB 5882, Section 128, Subsection 44) to "conduct a study on the current state of the data center industry in Washington and whether changes to existing state policy would result in additional investment and job creation in Washington as well as advance the development of the state's technological ecosystems."

Key Findings

The national data center market has been booming since 2012, both in terms of new construction and global demand. Profit potential for data center owners remains strong and margins are better than those available for other kinds of commercial construction, including Class A office space. Market competitiveness and improving technologies have made it more cost-effective for enterprises to move their workloads off-premise into independently operated data centers. Explosive growth in cloud computing has radically increased the size and economic impact of data center investments made by the four major service providers (Amazon, Facebook, Google, Microsoft) in the United States.

Growth in the Washington data center market has been on the low end of the market, both in terms of new construction and in terms of measurable gross business income.

The Seattle market has grown at about 3 percent year-over-year (YoY), which is essentially no growth given that market's unique demand for retail co-location next to the Seattle Internet Exchange (SIX) for interconnection purposes.

Three probable causes for Washington's lagging growth are identified: (1) lack of aggressive promotion of the state's data center economy and opportunities compared to other states; (2) historic confusion in the market about Washington's data center incentives, which may no longer be that competitive; and (3) concession of the urban data market to Oregon because the Seattle market is not competitive on the basis of sales tax.

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Conclusions

Data center growth in rural Washington is at the lower end of the growth rate experienced by other major competitive markets. The competition among states for data center projects has increased dramatically and, if the state desires to attract more projects, Washington should improve its promotional strategy for this industry segment and reexamine the competitiveness of its overall incentives strategy.

Urban Washington counties that do not have access to sales and use tax exemptions for data centers are at a competitive disadvantage to other urban data center markets such as Portland that either do not have sales tax or that offer tax incentives that abate the sales tax.

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Introduction

The data center industry is experiencing explosive growth but Washington has captured relatively little new business.

To better understand this issue, the Washington State Department of Commerce (Commerce) was directed in the 2017-19 Operating Budget (SSB 5882, Section 128, Subsection 44) to:

conduct a study on the current state of the data center industry in Washington and whether changes to existing state policy would result in additional investment and job creation in Washington as well as advance the development of the state's technological ecosystems

Report Organization

This report provides an update on current data center economics to explain how data center markets now operate and what motivates its primary actors. It then provides an overview of measures of data center market health. Data center market trends and recent deal flows for the United States are presented along with a benchmark growth metric for a healthy data center market. The Washington data center markets are described and evaluated vis-?-vis that benchmark growth metric, followed by analysis. Appendices provide additional insight into the regional competitive situation with Oregon.

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Data Center Economics

There are two perspectives important to understanding data center economics. First, there is that of the data center owner, typically also the operator, who views the data center much like any other real estate investment. They are motivated by the overall profit that can be obtained from the project, so they are focused on their return on investment (ROI). Second, there is the data center tenant, the customer that leases space, power, and telecommunications interconnect from the data center owner. The data center tenant is motivated by their total costs of ownership (TCO).

A variant of these is the off-premise enterprise data center, such as those run by Microsoft or Amazon, where the owner and the tenant are one and the same. These operate as cost centers to the enterprise, so their operators are focused on TCO, but at construction the enterprise data center is also motivated by the same capital-cost issues that data center owners have.

There is an important caveat to any treatment of a data center economy. Data center owners and tenants treat their customers, finances, contracts, and construction data as confidential information. While local economic development authorities, site selectors, and government officials do release data center project information to the public, often that information is incomplete.

Moreover, there is no consistent repository for this information nor are there any consistent set of reporting metrics. Even the physical size of a data center can be misconstrued, as there is a difference between the amount of space available for housing servers (i.e., the data center floor) and the overall size of the building, which includes space for offices, HVAC, and other operations ? and companies are not always clear about or consistent in what they report. In short, there is an inherent lack of precision in the data. This imprecision follows also in state of Washington data, where "data center" is not its own North American Industry Classification System (NAICS) category. This report thoughtfully distills and presents what is salient; while the narrative is accurate, there is some inherent roughness in the data.

The Data Center Owner

Many data center owners started as real estate development companies that branched into data centers. In Washington, examples of this would include the Sabey Corp. and Centeris. Others are global real estate investment trusts that specialize in data centers, such as Equinix and Digital Realty Trust. Data center owners can also be telecommunications companies (e.g., CenturyLink) or enterprises (e.g., Apple or Google).

Data centers require high-capital investments to build, not just for the buildings themselves but for the roads, power, fiber, water, HVAC, fire suppression, and other infrastructure costs that must be incurred. Customers demand sophisticated designs and services, so data center

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owners have to stay current on globally accepted criteria such as the ANSI/TIA-942 standard.1 These standards evolve over time,2 so to stay certified data center owners have to continually invest in upgrading their equipment and processes. Thus, the ROI calculation used by data center owners includes a large initial outlay of capital at the beginning of the project and upgrades to the infrastructure on a perpetual three- to five-year cycle.

The economically productive life span of a typical data center is 10-15 years, so this defines the ROI horizon of these projects.3 Aging data centers do not capture the premium rents that newer and more efficient data centers command, so the data center ROI profile is not dissimilar to that of Class A office space.

Data center owners are as knowledgeable and sophisticated as large-scale commercial builders. As such, their investment decisions are based on complex models that take into account as many as a hundred decision attributes. The critical decision criteria that most impact their ROI are:4

Land costs. Power costs. Net taxes (after incentives). Construction costs. Equipment costs, especially costs specific to a particular geography. Labor availability and cost. Regulatory and operating environment.

The data center owner is also going to account for customer proximity, geographic and weather stability, geographic accessibility (airports, roads, etc.), fiber density, and other risk factors. However, the criteria bulleted above are the most economically significant. Facility construction and infrastructure provisioning average about 71 percent of overall project costs. Power and taxes account for about 22 percent of project costs, while land acquisition and labor costs account for the rest.5 Land costs, construction costs, equipment costs, and labor costs do not greatly vary among potential sites outside of very large metropolitan areas, so power costs and net taxes tend to be the most significant economic differentiators.6

Despite very high capital costs, data center owners have a capitalization rate of around 6.5 percent, compared to 3.3 percent for Class A office space.7 The higher returns are due to

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lifespan-40042593 4 5 6 7

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