Are U.S. Data Centers at a Saturation Point?

Google’s former director of global infrastructure acquisitions, Erikas Napjus, warns that the U.S. and London data center markets could be on the cusp of a bubble.

The U.S. data center market could be close to saturation, with investors urged to consider “getting out of the sector” within the next five to 10 years.

Erikas Napjus, managing partner of the data center consultancy firm Zenzu and Google’s former director of global infrastructure acquisition, says the retail data center space—where tenants sign shorter-term leases for a rack, space within a rack, or a caged-off area within a facility—is suffering the most.

“There’s been so much incremental growth in the enterprise area [retail data centers], but as people in the U.S. and internationally go to the cloud, this is where things will suffer,” says Napjus.

Internet giants such as Amazon, Facebook, and Microsoft are investing heavily in mega data centers, which research firm International Data Corporation estimates will account for more than 72 percent of all service provider data center construction by 2018. Napjus also argues that increasing competition from wholesale data center providers that typically lease entire data centers to a single tenant, who is then responsible for all IT operations, would drive consolidation in the sector as wholesale providers move into the retail space in search of growth.

“After the financial crisis, investors realized that data centers were one part of the market that was pretty solid and sustainable,” says Napjus. “That was around the time that the smart private equity money was flowing into the market.” Napjus advises public and private investors and firms on sourcing data center sites, infrastructure, entering new markets and evaluating data center management teams. “In the past five years, we’ve seen a lot of growth and are now seeing that early private equity money starting to back out of the sector and sell their assets,” he adds.

As capital continues to flow into the sector, Napjus adds, “this second wave of investors entering the data center space may not realize they are entering on the cusp of the next bubble. In some cases they might be creating the next bubble.”

The issue isn’t just restricted to the U.S. market, however. Napjus says London and Amsterdam are also on the verge of potential saturation. “The shoe is about to fall in some of these developed markets. London definitely feels that way.”

Instead, data centers in emerging and frontier markets—as well as on the edges of core gateway markets in developed countries—can offer much better risk-adjusted returns, Napjus says. “The real opportunity I see is in markets where there are not the existing players, such as Latin America and South Africa. The risk profile of these markets has kept the established REIT players away, but if you are willing to notch up on the risk side and create a good company, you can be rewarded well for it.”

He also says edge data centers—located in the top 40 to 80 markets of countries such as the U.S. and regions such as Europe, rather than the biggest four or eight cities—are gaining traction and “possibly over time may end up edging some of the wholesale and highly connected data centers out.

“There is a great opportunity to become a leading data center provider in these markets, if just 20 percent to 30 percent of the market moves to Class B–type markets. That may happen over the next five years.”