Spotlight - Infrastructure

Data centres – an evolving asset class for infrastructure debt?

Franz von Abendroth, Head of Infrastructure

To date funding of data centre projects often fall in between chairs of infrastructure lenders and commercial real estate lenders. This seems at the verge of changing. Even mezzanine is now available to improve the capital structure of such projects.

New data centre capacity totalling 800MW is expected to be built until 2023 in the FLAP markets alone, resulting in a new growth record. Due to its long-term growth profile and structural tailwinds, the data centre sector is increasingly becoming attractive for equity investors and debt providers alike.

At the same time, the funding structure of data centre projects in Europe is changing. Until recently, the sector was dominated by senior commercial real estate lenders (“real estate lenders”), a group which consists of banks, institutional investors or dedicated real estate debt funds. An independent market observer could gain the impression that these parties mainly used conventional office or retail real estate financing techniques and as a result are often struggling with high fit-out costs and relatively low alternative-use prospects, which are both typical for data centres. Triggered by new market entrants discovering the sector, the financing approach is now slowly changing.

Data centre projects seem to fulfil basic infrastructure loan criteria

Some senior infrastructure project finance lenders (“infrastructure lenders”) have already defined data centres as a new infrastructure asset class and are applying an alternative financing approach. Whilst real estate lenders mainly rely on market values of the underlying real estate asset (LTV covenants) and consequently on the value of the mortgage which serves as collateral, infrastructure lenders predominantly focus on cashflows to be generated by the respective asset. Key infrastructure funding criteria like (i) long-term stable cashflows, (ii) long technical lifetime of the underlying asset, (iii) strong market position (i.e. demand exceeding supply) and (iv) a solid security package seem to apply for many data centre projects.

However, some infrastructure lenders continue to find it challenging to accept certain characteristics inherent in data centre projects. In particular, two main characteristics determine risk perception:

  1. Single-tenant (e.g. hyperscalers) data centres with long-term lease agreements in place, which seem to be a very good fit for infrastructure lenders.
  2. Colocation data centres with shorter-term lease agreements and changing lessee base over time, which seem less of a fit.

Other criteria are also crucial to the individual risk perception and lending appetite, such as

  • greenfield vs brownfield assets,
  • size (MW, sqm, capex),
  • location (edge vs regional vs FLAP),
  • counterparties (experienced developers vs new entrants),
  • layouts and fit-outs or
  • project finance – like date certain, turnkey, fixed-price EPC contracts.

Different lenders for different risks – as in other established asset classes

Going forward, we expect infrastructure lenders to gain more knowledge and comfort on certain asset characteristics, thereby establishing an individual niche focus within the data centre sector. This development could also be observed in other more mature infrastructure sectors such as fibre optic networks. Transactions ranged from “no brainers”, such as publicly backed optic fibre networks in tendered areas securing a monopolistic position (like in France), to more complex and privately funded networks including short-term customer contracts with a limited number of small-sized customers. With increasing familiarity of the sector, some lenders were prepared to accept a different risk pattern compared to other lenders.

Driven by increasing liquidity and additional lending competition in the sector, real estate lenders and infrastructure lenders will, in our view, get increasingly comfortable with data centres as an asset class. As a consequence, we expect an increasing amount of senior debt to be available to the data centre market in the coming years.

Mezzanine is available and will complete the capital structure

Aside from and complementary to senior debt, mezzanine financing should also be considered for data centre projects. Other mature infrastructure asset classes such as renewable energies have registered a strong increase in the availability of mezzanine debt amounts. So far, we have not yet observed this type of development in the data centre market as it is still at an earlier stage. However, including mezzanine in the financing structure would benefit data centre developers and owners by (i) limiting the equity bound to their investments, (ii) making use of freed up equity for new developments / investments and (iii) increasing equity return.

Berenberg’s dedicated Infrastructure & Energy Team already today provides mezzanine debt via its Debt Fund to the data centre sector. Funding can be provided for either green- or brownfield, colocation or single-tenant data centre projects in Western and Northern Europe. Please contact us if you would like to discuss your project with us.

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Date: May 2021