Through our close-knit relationships across our firm our full range of expertise is at your fingertips. Helping you deliver first class service to your clients across their personal and business worlds. Jenny Sargeant, partner lead of our specialist private banking team sits down with datacentres partners Jonathan Cohen and Nick Wood.
In a nutshell what’s your area of expertise?
Jonathan Cohen (JC): I'm an energy lawyer covering everything except oil and gas, with the emphasis firmly on the clean rather than the dirty stuff! My clients fall into two groups: (1) Energy companies, whom I support across the full project lifecycle: planning, land, construction, grid connections, revenue streams, operations and financing; and (2) Energy-intensive projects, ranging from large residential developers to datacentre developers and investors. Right now, datacentres are the busiest of these markets.
Nick Wood (NW): I am a development and investment real estate lawyer who specialises in infrastructure assets, including datacentres. Datacentres sit at the intersection of traditional real estate development and infrastructure projects. There is a wide range of legal, professional and technical specialisations needed to come together, and so expert project management is key!
Why are we hearing so much about datacentres at the moment?
(JC): Datacentres are a really interesting asset class at the moment (as evidenced by the amount of press coverage the sector is getting) because sector growth globally is tracking increased demand for cloud computing and digital services, but also the AI boom. Central to this projected growth is the need for increased energy supplies and connections which requires significant government and private capital expenditure. Development and growth in the sector is happening at the same time as this investment into the infrastructure is being deployed, so there are lag times between when grid connections will be available and sites going live (sometimes with as much as a 10-year gap). Private solutions (such as onsite generation) are key to site delivery in the meantime. The UK government is, for now, keen to incentivise datacentre development as they see it as central to the UK’s economic growth and ability to attract inward investment. There are high returns and opportunities for developers and investors who get things right. There are also risks to mitigate in operating a fast-paced and dynamic growth market. Embedding current market-standard practices into structuring and documentation with an eye to how these are evolving is critical to ensuring long term bankability and robust investor exit strategies.
What are the main dynamics to be aware of in relation to datacentre investment and development?
(NW): I am asked this question a lot at the moment! At the front end, power and land are the keys to putting together a datacentre development but, of the two, power is the more difficult to source. As a result, many new developers are coming into the sector from an energy background (predominantly renewables) rather than a real estate background. A lot of my role for these new entrants is familiarising them with the real estate considerations that apply to any development (such as conditional sale agreements, power, planning, construction, and ultimate leasing structures). The datacentre nuances that overlay these standard considerations are as follows:
Capital expenditure: the levels of investment to get a site up and running are huge. Around 60-80% of a datacentre’s build value and capital expenditure is allocated to MEP (Mechanical, Electrical and Plumbing infrastructure), bare land accounts for only about 5-10%. To allow this investment to amortise, most operators will want to have full ownership control of the site.
Security/control: it’s crucial that the technical areas are secured. Rights over a datacentre site therefore need to be carefully considered and guarded.
Connectivity: connectivity to power and fibre is really important and rights to connect and use both of these and the level of those connections is critical to the ultimate operation. Specialist technical diligence is required to check there are adequate rights and networks and the potential for future connections to be made.
Leasing: a complete development (“ready for service”) is ultimately leased to a customer. The role of the landlord operator in these documents typically assumes more risk than a traditional landlord would have to and significant risks and penalties attach to failures to provide required levels of key services such as security, power supply and temperatures. This is why these issues require such careful scrutiny up front.
For UHNW clients, it is unlikely that they will set up as specialist developers or operators. Datacentres are a very niche and specialist asset class. However, a “triple net” or “wholesale” lease to a customer (such as a telecoms company) or even to an operator who runs the site may present opportunities for them to enjoy some of the benefits of having a datacentre in their portfolio. An attractive aspect of this is that the significant fit out cost makes it more likely that a tenant will stay for the long term. This can be very attractive in providing long term income with specified rents and set rent review uplifts backed by strong covenants (so can have the feel for investors of a bond). However, the downside of this is that a highly specified datacentre may be built to current technological requirements, but that may make it difficult to repurpose if and when the technology evolves, or a change of use is desired. It is likely that a lot of the equipment will benefit from Code rights (rights for telecoms operators under the Electronic Communications Code), which adds to the complexity of repurposing when the datacentre use ends. So, there is an element of risk with this strategy too.
Who are the players in the market and where are the investment opportunities?
(NW): The main customers in the market have traditionally been the “hyperscalers” (cloud providers such as Microsoft, Amazon and Google). However, enterprise customers including big banks and insurers – i.e. those companies with large data needs – have always stimulated some diversified demand, and there is an emerging customer known as the “neocloud” (cloud computing provider built specifically for AI). These customers build and operate their own datacentres but they also contract with operators. The operators include the likes of Ark, Colt, CyrusOne, Digital Realty, Equinix, Kao Data, Virtus, and NTT. As mentioned above, operators tend to prefer to own their sites, and there are not many leasehold deals in the market, although there are some exceptions, particularly on Segro’s Slough estate. The main opportunities for private capital investors will be buying assets leased on a wholesale / triplenet basis, as described above, or in participating in the development process (particularly getting sites “ready to build” for the operators and customers). One such area of opportunity is in identifying industrial sites with routes to power that may enable them to be redeveloped as datacentres. Even these investment opportunities require partnering of capital and expertise though, given the unique and sophisticated nature of your target buyers.
When do you come across private banks or their clients in your practice?
(JC): Many family offices and private capital clients have clear sustainability and ESG criteria and invest in green investments and renewables as part of meeting those. Their familiarity with renewable energy makes them well placed to look at datacentre opportunities which offer higher rates of return than standard real estate development and investment. Given the growth in the datacentres market and projected growth (and press coverage of this) we anticipate more and more private capital clients looking to add datacentres to their asset portfolio and looking for their private bank to support them with that. The sector is also gaining popularity with private equity investment, with many of their key players being clients of private banks in their personal capacity. So, datacentres are set to have an increasing profile within the private capital ecosystem.
(NW): These assets are very attractive to private capital clients offering high returns within real estate and yet having many characteristics of stability that real estate assets bring. A lot of property companies including family offices are looking to include datacentres within their portfolio. From a financing perspective, the scale of a lot of new projects does lend itself to club and syndicated financings which would allow banks to build familiarity with the sector to initiate themselves without having to lead as agent.
Can you give an example of where you best add value?
(JC): By having a deep understanding of the sector that my clients operate in; with datacentres you need to understand how they are built out and the underlying revenue streams. I also always have an eye on the need for bankability and investor exit. This is challenging within a fast-paced and dynamic market as market standards are constantly evolving. You need to be immersed in the sector to have an eye on the future and build room into legal documents to allow for technological development and change.
(NW): I add value by bringing together and managing the multidisciplinary team across IT, infrastructure, powered land contracts, construction, planning, tax all coordinated through a single contact point for our client. I also use my insight as a real estate lawyer to supplement my clients and operators’ knowledge around the mechanics of land transactions.
Do you have a mantra or saying that best describes how you work?
(NW): Be relentlessly positive. Whilst we are trained to identify and manage risks, what transactions and clients need is positive solutions and proactivity to move deals forward.
(JC): Be immersed and be an expert. If you genuinely enjoy the challenges of a growing dynamic sector, the growth from becoming an expert and the opportunities for your client, you become immersed in the ecosystem. That sits at the heart of being able to provide first class service. It also embeds you into the network of players in this niche market and allows you to connect market participants and engage on a level that is broader than being a pure legal advisor.
What do you think is key to assisting UHNW families in your area of expertise?
(JC): Understanding their business and investments and applying your knowledge to it. A lot of these entities are very entrepreneurial and agility of mindset from their advisors is key to meeting their expectations.
(NW): Helping them know what they don’t know. People are often quite quick to opine on datacentres but they are a very specialist and technical infrastructure asset.
How do you help private banks deliver first class service to their clients?
(NW): Private capital clients are continually looking for newer ways of realising value in investments and they want their bank to be open minded and go on the journey with them into new asset classes. They want credit teams to be open to being educated about the nuances of the asset and how that will present in reports and valuations. Being immersed in the sector we can help introduce banks to the right advisors and professional team (surveyors, valuers, project monitors) to guide and assist.
(JC): Anyone that is not looking at new markets is missing opportunities. Private capital clients expect their advisors (including their banks) to be adaptive to new markets and understand the risks and rewards. We are happy to be a trusted advisor who supports teams going through this “market learning journey” to educate around market standards and key trends and introducing them to our network.
What would be the “one thing to watch out for” coming ahead in your area?
(JC): The hot topic at the moment is grid connection reform. But there are significant lag times to getting connections live. So key priorities for developers are intermediary power solutions to mitigate connection delays. It’s all about using private solutions to bridge the gap before government funded schemes go live.
(NW): This is an asset class in cautious, uncertain and yet somehow explosive growth mode, as it is linked to AI and our relationship with AI. Datacentres are in the spotlight at the moment as they are the physical embodiment of AI. There is a lot of commentary in the press about the opportunities and risks around use of AI. Whether or not growth of the datacentre market reaches the potential heights predicted depends on how quickly issues around AI development are unlocked (if and to the extent they are in the short and medium term). It is a fascinating, evolving landscape.
Our connections across our firm are here to provide you with all the expertise you need so if you want to continue any of these conversations or have any datacentre queries, please feel free to get in touch with Jonathan or Nick.
For more information about Datacentres, please visit our website here.
For any Private Banking related queries please contact Jenny Sargeant.
