DFW Emerges As Top Five Data Center Market
Development of data centers is surging across the Dallas-Fort Worth (DFW) metroplex, and the party is really just getting started.
According to research from JLL, DFW is the fourth-largest data center market in the country in terms of supply with approximately 3.7 million square feet of inventory providing 505 critical megawatts of power. DFW’s development pipeline spans more than 1.1 million square feet of new projects totaling about 215 critical megawatts that are either planned or already under construction.
Data centers typically produce about 150 watts of power per square foot. A facility’s total power intake minus the portion needed to cool the equipment represents its critical megawattage — its true capacity for storing and processing data.
A number of state-level factors have contributed to DFW’s rapid ascension up the national data center ladder. Texas possesses a great deal of fiber optic connectivity, which gives users fast, reliable transmission of data and helps reduce costs. In addition, the state has its own power grid, as well as an abundant, cheap supply of natural gas to fuel power costs, which are typically the most expensive operating item for data centers.
An arid climate, ample available land and friendly development policies have also made the state’s largest metro area an attractive place to build.
At the local level, DFW benefits from a deregulated utility sector that assures one of the cheapest rates in the country, according to industry experts. The high number of corporate consolidations and relocations to DFW over the past several years — Toyota North America, JPMorgan Chase, Liberty Mutual — has also brought to the metroplex waves of digital records and information that need a place to be stored.
Research from CBRE ascribes a similarly high ranking to DFW, noting that its 19.1 megawatts of absorption through the first half of 2018 is the third-highest total among major American metros.
Rental rates have dropped slightly over the last three years, as the market supply has more than doubled during that stretch, but not enough to deter healthy absorption.
The building boom has caused DFW’s data center vacancy to spike to 19.2 percent, an increase of 40 basis points year-over-year, according to data from CBRE. But brokers are quick to insert an asterisk beside that figure.
“About 35 percent of the vacant space is Class B product that has been used and vacated and really requires additional capital investment to compete with new space,” says Haynes Strader, a data center specialist and senior associate at CBRE. “But the cost of building a new facility versus retrofitting an old one can often favor new construction.”
Strader notes that the older space that constitutes about a third of DFW’s total inventory translates to 15 to 20 megawatts of capacity. Local, non-tech companies are likely to be the primary users of these properties. In addition, he says some of those facilities can be repurposed into lab space for companies that are testing equipment or servicing telecommunications and tech firms.
“Taking down space for data center users is daunting because it’s expensive and involves housing sensitive information,” adds Brant Bernet, senior vice president at CBRE who leads the firm’s data center solutions team. “If you can find first-generation space at an aggressive rental rate, it doesn’t make sense to save a few bucks by taking second-generation space that might not be as secure for your data and equipment.”
Bernet also says that land availability in DFW puts the market in an ideal position for rapid expansion. Whereas the Northern Virginia market, the No. 1 data center hub in the country by a wide margin, only measures about four miles across, DFW’s market spans about a width of about 36 miles.
“At some point, land constraints are going to slow down the pace of development in northern Virginia, which also has a lot of single- and multifamily development happening now,” he says. “Purely from a land perspective, DFW is going to be able to provide space for the big users for a long time.”
Supply in Northern Virginia is about 40 percent greater than that of DFW. But supply totals of the runners-up — Chicago and Silicon Valley — barely exceed those of DFW. Given that the metroplex has, according to JLL’s data, about 42 megawatts up new space under construction — the third-highest total among American markets — DFW could easily capture the silver or bronze medal by 2019.
An Array of Users
Despite healthy growth in the data center space, many still believe DFW has not realized its full potential. Hyperscale cloud users —Google, Amazon (AWS), Oracle and Microsoft — have only skimmed the surface in DFW.
“In DFW, absorption is diverse in terms of industry verticals,” says Ali Greenwood, senior vice president of data center solutions at JLL. “Between financial services, insurance and healthcare, technology, and telecommunications, it’s a healthy mix. But with the new supply we’ve added over the last 18 months, we’re positioned well to attract more of the hyperscale cloud companies.”
Greenwood adds that the general growth in how companies utilize technology in their daily operations is contributing to the strong absorption in DFW. She points to companies like NCR, an Atlanta-based firm historically famous for electronic cash registers, has revolutionized their business from a technology perspective to become the world’s #1 POS software provider for the retail and hospitality industries, inventor of magnetic credit card strips and chip technology, self check-out kiosks, and even mobile airline board passes. As these devices become more widespread, the amount of space needed to store the digital information they transmit grows.
“NCR has effectively become a cutting edge software company, and this type of evolution into more tech-savvy companies is driving data center absorption,” she says. “It’s like [JPMorgan Chase CEO] Jamie Dimon recently said, ‘We’re not just a bank anymore, we’re a technology company that moves money.’”
According to JLL’s research, major cloud users account for only 28 percent of demand for data center space in DFW. Technology and financial services sectors each eat up about 23 percent, with healthcare, entertainment and retail/e-commerce users combining for another 15 percent of the demand.
By contrast, in the larger markets of Chicago and Silicon Valley, hyperscale cloud users comprise about 35 and 40 percent of demand, respectively. Demand for data centers space in Northern Virginia largely remains a factor of government and defense operations, as well as entertainment and media.
Yet the footprints of cloud users are rising in DFW. Facebook’s 1.5 million-square-foot data center in Fort Worth — a project with a price tag in excess of $ 1 billion — has nearly maxed out both its acreage for new development and its current supply of leasable space.
In Midlothian, located about 25 miles south of both downtown Dallas and Fort Worth, Google has acquired 375 acres for new data center development. That project is expected to bring $500 million in capital investment to the region and create several dozen new jobs.
Absorption Draws Investment
Greenwood of JLL notes that the DFW’s first-half absorption, which is on pace with historical averages, indicates a high volume of transactions in the marketplace. Healthy deal velocity has drawn more investors and developers to the market.
“Properties in DFW continue to see low cap rates, due to its status as a top-tier data center market and data centers maturing as an asset class. That’s generating more investor interest,” she says. “We’re also seeing more foreign capital enter the metroplex and an increased number of bids on assets for sale.”
The third-largest sale to this point in 2018 occurred in DFW earlier this year when California-based REIT Equinix acquired the 1.6 million-square-foot Infomart Dallas from ABS Real Estate Investments for $800 million.
“Data center operators have historically focused their developments in fiber-rich cities with lots of enterprise, and Texas fits that profile very well,” says Jonathan Lin, vice president of corporate development and strategy at Equinix. “It’s safe to say investment has been strong across the board. We have seen no slowing or negative changes in investment, pricing or cap rates.”
Gary Wojtaszek, CEO of Dallas-based REIT CyrusOne, says that the same basic features that draw commercial real estate investors to DFW— a low corporate tax rate, educated workforce, pro-business environment — are equally applicable to the data center market.
“The only thing the state could do if it really wanted to accelerate data center growth would be to devise a tax plan that mirrors that of Northern Virginia,” says Wojtaszek. “But in general, demand for date is exploding, and as Texas and DFW keep growing, you’re going to see more capital deployments here in coming years.”
Paul Moser, co-managing partner at Stream Data Centers, the data center development and operations arm of Stream Realty Partners, notes that healthy investment demand for data centers is also prompting more speculative projects in the metroplex. His firm is developing a 400,000-square-foot facility in Garland, a northeastern suburb of Dallas. That project is slated for a second-quarter 2019 completion.
But it’s not just the investors that are warming to data centers in DFW. Lenders are now seeing the asset class as a legitimate vehicle and are developing a better sense of how to finance it.
“Lenders are undoubtedly becoming more educated on the product type,” says Moser. “You’re still likely to get lower leverage, maybe 50 percent, on a spec project. But for investors seeking a fully leased building with creditworthy tenants, the floodgates will open and you can get 70 to 75 percent loan-to-cost (LTC).”
The ability to prelease a facility quickly also plays into lenders’ and investors’ thinking. According to Moser, in a perfect world, developers will begin marketing and preleasing space around the time they close on the land, though sometimes a project won’t have real interest from users until after development begins.
The other major metros of Texas are seeing solid action in the data center space. According to JLL, Austin and San Antonio have collectively experienced nearly 10 megawatts of absorption through the first half of 2018.
However, much of that absorption came from a single user, Microsoft, which has built and owns several facilities in the San Antonio area. Still, the Austin/San Antonio market demonstrates the impact that hyperscale users have on absorption and development: as a result of Microsoft’s big moves, there is currently no new space under construction and scarcely 100,000 square feet of new product planned.
JLL puts the size of Houston’s market at just over 1 million square feet. But the pipeline of new construction, none of which has broken ground yet, totals more than 500,000 square feet.
This figure suggests that data centers are receiving their fair share of newfound economic bullishness in Houston brought on by rising oil prices. In addition, the data center market in Houston is beginning to an increase in leasing activity from the city’s robust healthcare sector.
The average power rate in Austin/San Antonio is 7.2 cents per kilowatt hour, and in Houston, the cost of power is 6.5 cents per kilowatt hour, per JLL. In DFW, it clocks in at 4.5 cents. Most industry experts agree that of all the positives DFW can offer hyperscale users, this factor carries the most weight.
“The hyperscale guys will continue to come to DFW,” says Moser of Stream Data Centers. “This is too good a market for them not to have a presence here. Having supply and the ability to scale is very important for those users and we’re in a very good position to capture a lot of that business.”
— By Taylor Williams. This article first appeared in the October 2018 issue of Texas Real Estate Business magazine.