Tons of data, bricks and mortar

According to Gregg Spivey, the next big thing in infrastructure investing is data storage. Along with his colleagues at Pincher Fry & Benjamin (PFB), the investment manager is betting that capital used to build and operate high quality data centres near big cities in Europe and other regions stands to deliver “superior risk-adjusted returns”.

The reason for the bullishness is simple: data usage is growing rapidly, and storage facilities are failing to keep up with demand. Cisco Research estimates that global “internet protocol traffic”, i.e. the movement of data across networks, grew by 52 percent in 2008 alone, and has plenty of additional growth still to come. In the US, video sharing website YouTube.com is currently shifting more data than America’s entire internet infrastructure put together had to process in 2000.

The equipment used to enable all this traffic needs adequate storage space, as does the data itself. According to PFB, Europe has nowhere near enough of it, especially at the high quality end of the market.

It’s not just corporate self-interest that dictates digital information be stored safely and accessibly at all times; governments are increasingly insisting on it, too. In addition to cutting- edge systems, therefore, newly built data storage centres require an adequate and resilient power source. They need to be in the right location, and they also have to comply with ever more demanding environmental rules and regulations. 

“At the same time as demand is increasing, there is a shortage of ‘fit for purpose’ data centre space,” says Spivey. According to figures published by Richard Ellis in April, data storage centre vacancy rates in Western Europe have declined markedly in recent years.

The shortage translates into an investment opportunity that PFB, an £800 million London-based property investor established in 1998, has been focusing on for two years. In September 2007, it launched the PFB Data Storage Fund, which so far has raised approximately £56 million from high-net-worth individuals. The fund has assembled a portfolio of stakes in development-stage data centre sites in London, Frankfurt, Munich and Zurich.

Structured as a Guernsey-based closed end investment company and listed on the Channel Islands Stock Exchange, the fund now expects to continue its strategy of investing in projects situated in business and financial centres across Western Europe. To do this, it is seeking to raise another £150 million from institutional investors. 

As Spivey puts it, as well as satisfying many other location based criteria, premium data centre sites need to be situated “inside the doughnut” formed by two circles – the inside one being the minimum radius from the city centre to ensure security and safety from terrorism and other dangers, and the outside one to ensure that the data centre is close enough to the relevant tenant offices in order to operate efficiently.

In South East England alone, PFB believes current data centre demand is over one million square feet. It also says new, purpose-built centres such as those it is currently developing are in particularly short supply. This is because existing facilities are often not capable of supporting the latest computer equipment and cannot easily be upgraded to do so, for example due to a shortage of electrical power available at the site.

Barriers to entry

Central to the fund’s prospects is a joint venture with e-shelter, a Frankfurt-headquartered construction and operating company, which was founded in 2000 and has since built a track record in designing, developing, running and securing data storage facilities.  The fund’s
existing properties, which are yet to be let, are positioned to attract top-tier tenants such as large financial institutions. To attract these, the centres require state of the art technology, as well as an operator that tenants will trust.

“Barriers to entry in the sector are very high, not least because you need the operational experience and track record to give tenants comfort that this mission-critical function is in a safe pair of hands,” Spivey says. He is confident that in e-shelter, PFB has found the right partner.

Partly because of the barriers to entry, and also because of the long-term demand and supply dynamic in the sector, PFB says that the projects for which they are seeking equity funding are capable of “indicatively” delivering a net compound return of 24 percent per annum over the next four to five years. To achieve this, it will develop, let and then sell a portfolio of four facilities, thus generating a capital gain upon exit. Any rental income earned during the holding period will be used to more rapidly amortise the debt financing used to construct the facilities.

The global credit crisis and the economic downturn are affecting the project in ways Spivey describes as “interesting” – and on balance positive for the fund. The bottom line, he says, is that “the volume of data being generated has continued to grow at a rapid pace, and this data needs to be stored somewhere”. He also notes that users of high-end data centres are now leaning towards leasing space rather than building their own facilities, which is an important driver in favour of the e-shelter’s business model: “Companies that are now pricing their balance sheets differently will be more likely to switch from a cap-ex to an op-ex model; you won’t see them embarking on expensive projects so readily anymore.”

That said, Spivey is also aware that even to lease a new storage facility can be a capital-intensive undertaking, and notes that the requisite decisions will now be scrutinised at or near board level. “We expect tenants to take their time to evaluate the financial implications of a data centre lease very carefully.”

Despite this expected caution, PFB argues that the fund’s prospects are compelling. It currently has a 50 percent stake in the London-based facility near High Wycombe, with e-shelter holding the other 50 percent. In the Frankfurt, Munich and Zurich projects, the fund is a 16 percent shareholder, though PFB intends to use an option it has to increase its respective interest in the three sites to 49 percent once the additional capital has been raised. PFB believes that in a year’s time, the fresh funds being raised at the moment will have been invested – provided all goes to plan.