An undersupply of data centre capacity following the surge in AI and cloud-based demand creates long-term benefits for data centre investors, according to Gavin Truong, senior investment analyst, Quay Global Investors.

Most of the world’s data centres are in the US, where there are over 5,000 centres, with a combined capacity of over 7,000 megawatts (MW) – more than the combined capacity of the next four largest countries of China, Japan, UK and Germany.

Leasing demand for data centres is derived from two broad sources: hyperscale tenants or very large technology companies like Amazon, Google, and Microsoft, and smaller retail tenants such as banks, companies, and government.  

“The demand from AI is being led by hyperscale tenants, or the large US technology companies. The combined annual capital expenditure of Amazon, Microsoft, Google, and Meta has increased by 26 per cent from 2020 to 2023, with forecasts projecting a further 33 per cent increase by 2025,” he said.

“In recent months, global leasing activity has surged, achieving record-breaking levels in each of the past four quarters to 31 March 2024.”

Mr Truong says that remarkably, more megawatts have been leased in this twelve-month period than in the preceding three and a half years.  

“Hyperscalers are rapidly absorbing available space and power. Consequently, rents are growing. This looks likely to continue as current power capacity is absorbed and future supply can’t keep up with such strong demand.

The chart below shows the soaring demand for global data centres.

According to Mr Truong, supply is responding to this surge in the need for space and power in data centres. Capacity under construction in the US has grown to just over 3,000MW at the end of 2023. However over 80 per cent of current construction is already pre-leased, compared to around 50 per cent in prior years.

“This significantly decreases the risk of oversupply. Power constraints will also restrict the supply response. Generative AI requires a tremendous amount of power compared to conventional uses. Difficulty sourcing power and procuring generators and transformers are adding multi-year delays to the development timeline of data centres,” he said.

Mr Truong suggests that the potential investment returns are appealing. “With development profits of 40 per-cent-plus and stabilised net operating income yields of more than 9 per cent, developments are proving to be lucrative which may suggest supply could accelerate from here.

“However, due to the long duration (10-15 year) nature of hyperscale leases, strong rental growth does not quickly translate to outsized earnings growth. A significant portion of current rental rolls were signed back when leasing environments were less favourable. Landlords are trying to speed up this process by divesting ‘low growth’ data centres and reinvesting capital into new developments. Nevertheless, it will take time to play out, however the trend is positive.

“Globally there are just five listed pure-play data centre REITs, with exposure to developed markets. Only one of these is listed in Australia and, in our view, it is priced at a premium compared to global peers. At Quay, we have the ability to invest in better opportunities globally.”

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