Subscribe to the Data Center Knowledge Newsletter
Get analysis and expert insight on the latest in data center business and technology delivered to your inbox daily.
Financing for New Data Center Construction: An In-Depth Guide
A guide to financing for data center construction, exploring debt and equity options to optimize your investment strategy.
6 Min Read
Image: Alamy
Building a new data center is a significant investment, often requiring a strategic blend of debt and equity financing. The choice between these funding options hinges on various factors, including data center type, market conditions, and scalability needs.
This article provides a detailed overview of financing data center construction, offering insights to help you navigate the complexities and make informed decisions. Whether you’re planning a new build or upgrading existing infrastructure, understanding your data center financing options is crucial.
Debt Finance: Structuring Loans and Bonds for Data Center Projects
In the debt finance model for data center construction, banks can provide borrowers with either corporate finance or real estate finance. While corporate finance is reliant on the strength of the borrower’s balance sheet and collateral (such as land or buildings) being offered, real estate finance focuses on the asset value and its preservation during the loan period.
Loan Agreements in Detail
To ringfence ownership from the operation, loans are made separately to the property holding company, or ‘ProCo’ (the lessor), and operating company, or ‘OpCo’ (the lessee), due to the different risk profiles but sometimes for tax advantages.
In the case of hyperscalers with one or more anchor tenants and colocation facilities, project finance is tailored to a specific project, and repayment is based on the income stream upon completion of the facilities.
Traditionally, banks used to be the source of these loans, often through their syndication. In addition to the generic infrastructure risks, their assessment of the financing agreement would cover sector-specific risks pertaining to the stability of various elements including power/water supply, technology obsolescence, and contract income.
Hyperscalers would usually procure Power Purchase Agreements (PPAs) giving assurance on energy input, and their income disruption risk is regarded as being low. Colocation data centers, on the other hand, would be subject to a more rigorous evaluation of income risk due to potentially volatile lease renewals or lease termination in the multi-tenant scenario.
In terms of working capital used in the purchase of IT and networking equipment, build-to-fit data center operators may find letters of credit useful, as banks are willing to extend this short-term credit facility as part and parcel of their overall loan arrangement.
Building a new data center is a significant investment, often requiring a strategic blend of debt and equity financing.
Loans vs. Bonds
In addition to loans, bonds may be issued by an operator to raise debt finance from the capital market, but a good credit rating is usually necessary to attract institutional investors.
Short-term bonds, called notes, may be sold by securitizing the incomes of a portfolio of data centers. This has been common in the US, which has an active bond market. However, comparatively speaking, loans still prevail over bonds in terms of issue volume, especially in countries (e.g., in Asia) where the secondary market for bonds has yet to be fully developed.
In Europe, where securitization deals are not as common, the potential use of trade receivables for financing data center construction has been mooted, since rentals and service fees arising from Data Center-as-a-Service (DCaaS) are a steady source of income and regarded as a current asset.
Data center operators may make use of the existing Asset-Backed Commercial Paper conduit set up by a sponsor bank or financial institution to raise the necessary short-term finance (up to 270 days).
To decide on whether bonds or loans be used for debt financing, data center operators would need to gauge factors including relative interest rate levels (and hence bond issue prices) in the prevailing market conditions, issue procedures (a bond issue needs a good credit rating and possibly a prospectus), tax implications (for both the issuer and buyers), the maturity status of the secondary market for bonds, as well as tenor.
‘Green Debt’ Financing for Data Center Construction
With the advent of climate mitigation efforts and regulatory reporting impositions, sustainability is being factored into the financing of recent infrastructure development.
Increasingly, data center construction has been funded by “green debts” globally. There are two variants: Green Bonds (GBs) and Sustainability-Linked Loans (SLLs). GBs are subject to monitoring as to the use of the proceeds (supposedly towards achieving environmental benefits), whereas the interest rates of SLLs are subject to upward or downward adjustments related to the achievement (or otherwise) of environmental Key Performance Indicators (KPI) within a stated time frame.
For data centers, these KPIs relate to energy and water use efficiencies such as PUE and WUE, or the extent of using renewable energy, but there is not a standardized set since the locality of data centers matters.
Examples of recent green data center financing include the $4.9 billion green bond offerings by Equinix for its global projects, and the $280 million green loan extended to Princeton Digital Group’s new data center in Johor, Malaysia.
Data center operators may find lines of credit useful for the purchase of IT and networking equipment.
Equity Finance: Raising Capital Through Shares and Private Investment
Data center operators with a good track record may consider tapping the equity side for long-term funds through private placement of shares, public launch of new stocks, or rights issues (for additional subscription of stocks based on existing holding).
Possible downsides of stock issuance include the dilution of control, the associated listing procedures, and additional expenses. The amount raised in the public market depends on the capital market sentiment and volatility.
Recently, due to the positive outlook on the demand for data processing, data storage, and the incorporation of artificial intelligence (AI) in many walks of life, private investment fund houses including Blackstone, Brookfield Asset Management, and KKR are raising their stakes into the data center industry.
In the period 2018-2023, private infrastructure equity has accumulated $600 billion. Extrapolating from a study by Acres Management Company, private debt could reach $1.5 trillion for infrastructure within five years from 2022. Blackstone, for instance, is reported to hold $55 billion in data center portfolio, including projects in construction.
Private funds have the advantages of flexibility, supporting projects at different stages of development and supplementing bank loans, if not overtaking them in times of heightened regulatory control on bank lending.
Future-Proof Financing: Construction Contingency Plans
Whatever funding mechanism is adopted, suitable contingency funds must be raised to allow for design modifications that may be required due to increased demand or technological advancements (as in the emerging cases of liquid cooling, high rack density due to AI workloads, and supercomputers).
For debt financing, it is always prudent to consider the need to refinance when maturity is reached. This is especially important when funds were obtained at interest rates higher than the prevailing levels at the point of refinancing.
To mitigate the possible repayment risk in the event of a borrower’s default, lenders typically require a tripartite deed including the tenants to impose restrictions on lease termination, as well as enabling the sale to a suitable third-party operator when needed, in exchange for a promise of non-disturbance in the data center use by the lenders.
For equity financing, due diligence should play a central role in ensuring that the investors do not take on excessive liabilities inherent in the stock of an existing operator.
About the Author
You May Also Like
