Here's why big investors like Goldman Sachs, KKR, and Blackstone are betting billions on data centers

By Daniel Geiger

Scrolling through videos on social media may seem like carefree fun, but the logistics behind it are an increasingly serious business.

ByteDance, the China-based parent company of the social media streaming service TikTok, has leased 53 megawatts of data-center space across three locations in northern Virginia, a source with knowledge of the transactions said, facilities that could consume more annual power than 25,000 homes. That's on top of 9 megawatts ByteDance leased in 2019, according to data from DataCenter Knowledge. 

The company, which has come under scrutiny in recent months from the Trump administration, is just one among an expanding universe of businesses for whom data centers are key.  

In Totowa, New Jersey, meanwhile, Digital Realty Trust, a $41 billion public real-estate company that is one the country's largest data-center developers, has broken ground on a sprawling 600,000-square-foot complex after locking down a major commitment from Bloomberg LP, the financial data and media firm, several sources with knowledge of the transaction said.

A spokesman for Bloomberg did not immediately respond to a request for comment. ByteDance did not respond to an inquiry about its data-center deals.

The transactions are just the latest activity in a booming sector that straddles both the technology and property markets.

Data-center demand has dramatically risen in recent years thanks to a host of drivers. Those include the growing consumption of storage-heavy streaming content, the proliferating internet-of-things that has connected everything from cars and appliances to remote software and systems, and also the increasing migration of businesses to cloud based storage and applications.

Read More: We talked to 8 studio execs, investors, and brokers about the big money pouring into film and TV production spaces. Here's a look at the opportunities — and risks — for this hot real-estate play.

The coronavirus pandemic, while causing other areas of the real estate industry such as retail and hotels to wilt, has only given lift to the already surging sector, experts say.

The audience data firm Nielsen, for instance, reported that US consumption of streaming content rose more than 30% through the first three quarters of the year to 7.1 trillion minutes as lockdowns and lingering virus concerns have encouraged more viewers to watch from home.

And as companies continue to put off a return to the office, more have scrambled to move more of their data and operations from onsite servers into the digital ether so that they can be more readily accessible to employees working remotely.

The lynchpin behind all of it are tens of thousands of megawatts of data centers.

Big investors like Goldman Sachs and Apollo are jumping in 

The demand has given a boost to established players in the industry, including public companies such as Digital Realty Trust and Equinix, the largest data center company by market value at over $71 billion. Shares of data center REITs have risen on average by about 25% this year, according to the REIT investment and research firm Cohen & Steers, compared to an overall 12% decline in the broader REIT market, which has been battered by the virus crisis.

The industry's performance has also caught the attention of major investment firms that want to make inroads into the lucrative business. On Tuesday, Goldman Sachs announced it had hired Scott Peterson, the former chief investment officer of Digital Realty Trust, and Goldman's merchant banking division plans to invest $500 million from an infrastructure fund to make up to $1.5 billion of data center acquisitions in the US and around the globe.

Read More: Real-estate developers are building costly cold storage space before they even have tenants lined up. They're betting the risky move could be a winning investment as grocery deliveries surge.

Other bluechip investors have crowded into the market as well. Apollo Global Management announced last week that it purchased a portfolio of nearly 500 existing cellular towers and hundreds of additional tower sites that are under development. That infrastructure is seen as closely linked to the data center business, especially with the arrival of 5G, whose faster speeds will require both more transmission infrastructure and storage space and increasingly seamless connections between the two.

In May, KKR said it would invest $1 billion from an infrastructure fund it operates to build and buy data centers in Europe in a venture called Global Technical Realty. And last year, Blackstone announced it had acquired a 90% interest in seven data centers in Virginia owned by the property REIT Corporate Office Properties Trust in a deal that valued the buildings at $265 million.

"Global internet traffic has grown 20% to 30% per year and the amount of data in data centers is growing at about the same pace," said Nadeem Meghji, the head of US real estate investments for Blackstone. "And with the arrival of 5G, you'll see the consumption of even more content from people's phones and devices."

Meghji also expected broad demand from businesses across the economy to continue to fuel growth.

"Only 30% of companies have moved their data storage off premises into a data center so far," Meghji said. "That adoption will grow."

Data centers require enormous amounts of power

Unlike other property types that have attracted robust investor interest in recent years, such as warehouse space, data centers can be particularly complex and expensive to operate and build. Most require enormous supplies of power, backup generators to prevent outtages, robust ventilation systems to cool football field sized rooms crammed with servers that can reach ovenlike temperatures, and connectivity to established networks of fiber optic cabling that serve as the nation's superhighways for data.

Development has nonetheless boomed as capital has flooded in.

"You're getting pension funds investing in data centers now, which is a huge change from a few years ago," said Steve Berkman, a real-estate attorney at Paul Hastings in San Francisco who has worked on data center deals on the West Coast.

The amount of new colocation capacity in leading data center markets such as Northern Virginia, Dallas, Silicon Valley, and the New York area grew by 5% in the first half of the year to 2.7 gigawatts of total inventory, according to data from CBRE, about 20% of the power consumed by all of New York City. Colocation spaces are akin to the coworking business in the office sector, offering takers flexible space in which to grow their data footprint. They are only a segment of the larger market.

Huge data consumers have also been active building and leasing their own facilities. Facebook recently began operating in a $1 billion data center it built in Henrico County in Northern Virginia, the country's largest and most active data center market. The social media giant has outlined plans to more than double the size of the complex.

Even more space is on the way, with about 373 megawatts of colocation facilities under construction, CBRE said.

All of that supply has put a modest strain on pricing in the industry, with average charges falling from $129 per kilowatt of monthly power consumption to $121 in the first half of the 2020 in those prime data-center markets, according to CBRE.

Developers have compensated for tightening profits by building and operating space more economically. Some data-center companies have even begun to experiment with the idea of submerging servers in tubs of mineral oil, which is more efficient at dispersing heat than air and can reduce hefty cooling costs. Microsoft has tested underwater data centers.

"A decade ago, the rule of thumb was it cost $40 million a megawatt to build," said Pat Lynch, a senior managing director at CBRE who oversees the company's data center solutions group. "Today it's a quarter of that, so there's still a healthy margin in the business even if prices fall slightly."

How a big supply pipeline is changing the competitive landscape 

The tightening economics and the large pipeline of supply are expected to prompt consolidation in the industry, allowing major players to enhance profitability by gaining economies of scale through acquisitions that avoid the risks of building from the ground up. Digital Realty Trust, according to several sources, was in talks, for instance, to purchase the $8.9 billion rival data center REIT Cyrus One last year, although the deal appeared to fizzle earlier this year.

The data-center industry's tenancy is dominated by huge customers such as Amazon Web Services, Microsoft Azure, Google, Oracle, and IBM, which use the facilities both for their own operations and multi-billion dollar cloud computing and storage businesses that cater to corporate and government clients.

Smaller companies too have found a niche, highlighting the diverse ecosystem of users behind the demand for data center space.

Data Canopy, a Maryland-based cloud-storage provider, has leased space in 16 data center locations across the country totaling about 10 megawatts that cater to small customers. Ryan Barbera, the company's founder and CEO, said he expects its footprint to as much as double in the next year and revenue to pick up by 30% or more. He is already contemplating a first fundraising round for the company.

"2020 has been pure growth for us from a business standpoint and the best year that we have ever had," Barbera said. "When Covid happened we frankly began implementing a lot of austerity. Instead, companies that in the past talked about a cloud transformation made the move after realizing it's just as important or more important than other areas of their business at a moment like this."

Disclosure: KKR is a large shareholder in Axel Springer, which owns Business Insider.

Have a tip? Contact Daniel Geiger at dgeiger@businessinsider.com or via encrypted messaging app Signal at +1 (646) 352-2884, or Twitter DM at @dangeiger79. You can also contact Business Insider securely via SecureDrop.