At its core, commercial real estate provides the physical spaces communities and cities need to support life and its activities. As communities develop, houses and apartments, shops, grocery stores, offices, and warehouses all follow to support the town. Now, data centers are joining that list. Technology adoption and consumption are catalyzing the need for facilities that can support our digital lives. Data centers are the physical spaces that house the servers that process, store, and distribute data. As technology adoption grows and new technology infrastructure expands, so does the need for spaces that can sustain it. The dynamic is creating an extraordinary opportunity for commercial real estate developers.
Here is a deeper look inside the tech adoption driving data center activity and producing attractive fundamentals for new development.
Rapid AI and Tech Adoption
More than ever before, companies across industries—including in commercial real estate—are turning to technology solutions and tools to create valuable efficiencies and optimize business performance. Sureel Choksi, chief executive of Vantage Data Centers, a leading provider and operator of data center properties, told the Wall Street Journal, “Arguably [AI] has been the fastest adopted business technology in history. “[It has sparked] “an arms race between all of the world’s leading tech companies.”
The numbers support the statement. From 2017 to 2022, AI adoption doubled, and investment in the technology is increasing at the same pace, according to a survey from McKinsey. Since the AI market has grown at the same pace with no signs of slowing down. AI market size is expected to grow to $407 billion by 2027, compared to a $86.9 billion value in 2022, and AI will contribute a 21% increase in US GDP by 2030.
The growth is driven by the tremendous adoption of AI tools, which includes everything from self-driving cars to ChatGPT. Nearly two-thirds of businesses have plans to adopt AI tools to increase productivity, and 25% of companies are adopting AI to bridge labor gaps. All of these trends are pointing to growing demand for data center space to support the widespread adoption and use.
Attractive Data Center Fundamentals
The infrastructure needed to support computers and new technologies isn’t new. Early iterations of data centers emerged in the 1940s to accommodate emerging computer technologies. In the last decade, however, the rapid adoption of cloud programs and generative AI tools has created an unprecedented demand for data centers to support tech infrastructure. To illustrate the demand, companies leased 2.4 gigawatts of data center space in the first three quarters of 2023 alone, according to data published by the Wall Street Journal. In all of 2022, companies leased 2.3 gigawatts, and only 1 gigawatt of space in 2021. The tremendous demand for technology is supporting an accelerated leasing market for data centers.
Northern Virginia, Dallas, and Chicago are the leading US data center markets, and this year, data center vacancy has fallen to all-time lows in each of those markets. Impressively, Chicago’s data center vacancy fell from 6.7% to 2.4% this year, and in Northern Virginia, the vacancy rate fell from an already low 1.8% to .9%, showing the extremely limited availability of space in the market. The low availability has, of course, put upward pressure on pricing and rents. This year, the average asking price for a 250-to-500-watt facility has increased by an average of 20%. According to data from CBRE, pricing is expected to increase another 15% this year. Overall, research from Goldman Sachs expects that AI will drive a 160% increase in data center demand.
An Opportunity for Data Center Developers
The insatiable demand—which in many ways recalls the ferocious appetite for industrial warehouses in the 2010s when e-commerce was taking off—is creating a challenging market for companies to find data center capacity. Last year, data center inventory increased nearly 25%, with supply increasing 18% in the three largest data center markets. Yet, as noted above, data center vacancy has fallen to historical lows this year, showing that the majority of the new supply was absorbed by the market. The demand has created a tremendous opportunity for developers to create new data center product. As a result, construction activity will increase to 3,000 MW this year, following an already impressive 25% increase in 2023.
In addition to the increased demand for data centers, the complexity of AI tools now requires even greater data center support than those early iterations in the 1940s to truly meet user needs. In the previous decade, a typical data center was 20 to 50 megawatts. Today, users are demanding an average capacity in the 100-to 500-megawatt range. These facilities are needed specifically to support AI technologies. This is creating yet another opportunity for construction, not only to increase supply but to provide the types of facilities that will meet user demand.
Advanced technology adoption should be very familiar to commercial real estate stakeholders. The integration of these technologies is happening in our industry as well, providing companies with the ability to optimize performance, make more informed decisions, and achieve investment targets. Modern real estate development software like Northspyre is a quintessential example. With the ability to manage the entire lifecycle of a development project, improve financial performance and allow developers to capitalize on opportunities in an increasingly challenging market, the software has been widely adopted by industry leaders. Today, the company has completed nearly 2,000 projects valued at more than $175 billion.
This is exactly the type of activity that is driving data center demand across the globe. Technology adoption isn’t slowing down. With it, is a coming a growing need for data centers—and a big opportunity for real estate developers to provide these resources.
Download our ebook “The Developer’s Guide to the Data Center Economy” to learn more about promising opportunities this asset class presents for developers to help shape a growing market and diversify their portfolios.
