APG on navigating China’s data center market

Graeme Torre, head of Asia private real estate at the Dutch pension fund manager, answers key questions about the emerging property sector in the country.

APG Asset Management made its second investment in the China/Hong Kong data center space this year. Managing director Graeme Torre explains the appeal, and challenges, of this growing sector.

What’s driving investor interest in data center assets in China?

Cloud computing, outsourcing of data services by corporates, electronic financial transactions and the roll out of 5G networks, among others, are increasing data usage. So, it’s simply a matter of choosing locations where those changes are occurring most rapidly and with the greatest scale. China springs to mind immediately when the sector is considered through this lens; with 854 million internet users, it is the largest market for data use globally, and it’s still growing.

Graeme Torre

How should private capital access opportunities in the China data center space?

If the investment capital is capable of taking operating risk, then direct ownership in a data center owner/developer/operator company with an asset heavy balance sheet of owned real estate makes sense. It gives investors exposure to the tangible assets and to the substantial and growing revenue streams, beyond floorspace rental and power supply. For investors required to take a more passive approach, funds or property-level JVs are possible but, depending on the revenue streams received by the investor, this typically limits the upside available.

Are there specific challenges to investing in China data centers? 

Reconciling the insatiable demand for data, and therefore data centers, with the environmental challenges of providing sufficient electrical supply to power these facilities. We urge our partners to secure the maximum level of renewable energy that’s economically possible. Governments are also looking more closely at the sector and its operators, so there’s an ambient regulatory risk.

Finding a partner that truly understands the sector and has a unique offering – one that will give an edge in a sector that’s rapidly filling with capital – offers real challenges, as does finding suitably knowledgeable advisors that can assist in underwriting investments.

Are data centers best managed as part of a private real estate or infra portfolio?

It depends on the investor’s mandate and required portfolio return. Assets leased and then capitalized using a low cap-rate present more like infra assets. A property investor may be able to accept low returns if their mandate permits. However, the sector requires a different perspective. Attempting to create simple real asset investments from data center property isn’t capturing the full value generation opportunity.

For most operators, the land and buildings are a small part of the overall capex required for such a facility. So, an operator’s ability to pay a premium price for the right property is considerable. To capture full value, it isn’t just a real estate ‘play,’ so unless you’re receiving the upside from the operations, there may be a better outcome for all if the assets are built by real asset investors and then sold on to operators. This avoids the risk of holding obsolete assets in due course as the technology of data storage develops.

Finally, what’s the outlook for the data center investment market?

Favorable – with the right partner, the right approach and the right choice of market. We haven’t seen a cycle in this sector yet and with the current ownership base. Data centers as an asset class have been percolating up into investors’ sights for several years now and have finally caught the attention of institutional capital. That probably means we’re going to experience some cyclicality in the performance of this sector in due course.