Information and communication technology, Japan’s largest industry sector, is about to get a further boost from the large numbers of data center projects underway in the world’s third-largest economy. Private real estate managers, investing under the umbrella of the new economy in Asia-Pacific, are targeting the sector to meet surging demand for digital infrastructure that supports consumption in all areas of work, life and play.

Tokyo already houses the largest cluster of data centers in the Asia-Pacific region, with 489MW of capacity and several planned investments, both in the capital and Osaka, set to make data centers a key asset within Japan. The market, which was valued at $7 billion last year, is projected to achieve a compound annual growth rate of 7 percent in the coming years.

“Japan ranks as one of the four Tier-1 data center markets in Asia and has traditionally been considered a leader in ICT for many years,” says Graeme Torre, managing director and head of Asia-Pacific real estate for APG. “The country currently hosts over 22 third-party data center service providers operating over 90 facilities.”

New projects in the pipeline will grow capacity on a large scale. In February, GLP announced it was investing ¥1.5 trillion ($12 billion; €10.9 billion), with a target of delivering 900MW of power capacity over the next five years. In its press release, the logistics real estate investor said it had secured land to develop state-of-the-art data center assets, with the first campus in Greater Tokyo expected to be ready for service in 2024. PERE reported that CBRE Investment Management, which closed its latest vehicle Asia Value Partners VI on $1.74 billion in October, is looking at making its first data center investments in Japan and Korea.

An opportunity arises

While the growth potential around data centers in Japan has received a boost following the covid-19 pandemic, its strong performance has deeper roots. “Fundamentally, the data center market is supported by the population of a metropolitan city,” Stephen Beard, head of data centers at Knight Frank, explains. “Tokyo has a population of nearly 40 million and a GDP of over a trillion dollars. This creates significant domestic demand.”

Japan’s demographics of a highly urbanized society, a high internet literacy rate of over 92 percent and growing adoption of cloud solutions make data center assets attractive for both domestic and international players.

Demand for the asset class has manifested itself in several recently approved projects. Japan’s Mitsui Group, for example, is partnering with investment firm Fidelity to build hyperscale data centers in Tokyo and Osaka. These data centers will be managed by the Fidelity-owned Colt Data Center Services and almost triple the company’s capacity to 140MW.

“Generally, data center investment in Japan is supported by increased use of digital technology, especially since covid occurred, and particularly with the increased use of data through final transactions, video streaming, 5G adoption and the outsourcing of corporate IT networks,” Torre adds.

Market nuances

Although Tokyo dominates Japan’s data center market, it is far from the only important locale in the country. “Japan is the second-largest data center market in APAC outside of China. The majority of the data center activity is clearly focused on Tokyo, but Osaka is certainly becoming a significant secondary market,” Beard explains.

Osaka is becoming a regional hub for cloud service providers, attracting companies including Amazon Web Services, Microsoft, Google and Oracle. Digital infrastructure companies Equinix and Digital Realty are developing data centers in the city, the former alongside Singapore’s sovereign wealth fund GIC, while Asia-Pacific logistics firm ESR announced its acquisition of a data center asset and developable land in Osaka with a total gross value of $2.15 billion.

Part of the reason why investors are looking outside the capital concerns the difficulty of securing power in Tokyo. Historically, sourcing a commercial power connection in the city can prove challenging. The Inzai data center cluster, 50 kilometers to the east of central Tokyo, was viewed as having huge growth potential until recently, with AirTrunk building a 300MW campus in the area in 2021. Now, this growth looks set to end, with Princeton Digital Group CEO Rangu Salgame describing it as “capped out.”

It is also worth noting the geographic – and geopolitical – advantages that Japan has as a country compared with some of its APAC rivals. “Japan is a staging post for long-haul connectivity from the US to Asia,” Beard says. “Plus, any data centers are not Chinese-owned, which provides additional political safeguards.”

Hyperscale data centers heat up

Japan’s current market landscape is approximately 70-30 split between retail colocation and hyperscale data centers.

There is more colocation due to early adoption of cloud and a relative lack of domestic cloud providers. As competition grows, hyperscale data centers are expected to overtake retail colocation to accommodate higher density needs from hyperscale platforms. The hyperscale market now represents 36 percent of demand in Tokyo but is expected to account for over 50 percent by 2026. In Osaka, it is set to rise from 48 percent to 65 percent over the same period.

In January, STACK Infrastructure, a hyperscale data center developer and operator, announced it was partnering with Oaktree Capital Management to develop a 36MW hyperscale data center campus in Inzai in the Greater Tokyo Area, in a project which will be known as TKY01.

While some question the sustainability of this growth, expanding digital technology use, early public cloud adoption and the advent of 5G mean the drivers of the hyperscale market cannot be dismissed as short-term factors.

Seizing the opportunity

Given the scale of growth predicted for the Japanese data center market, a number of real estate developers are looking to secure land rights with a view to working with a data center operator should a domestic or international player build a new facility.

“We believe that to accept the risk of producing these assets then creating low-yielding long-term properties leaves too much of the upside with the occupier,” notes Torre. “We prefer investing directly with a data center operator in creating flexible solutions, such as in new geographies, or technology advances, such as edge computing. We believe this provides us with an opportunity to generate more attractive risk-adjusted returns, shorter payback periods and higher investment yields.”

These yields may increasingly come from international data center operators. Japan’s largest telecom companies, including NTT DOCOMO, KDDI and SoftBank, all introduced 5G in March 2020, but a lack of domestic data center operators presents a competitive opportunity for both US and Chinese hyperscalers to accelerate cloud deployment and grow their market share.

“In the last 12 to 18 months, we have seen announcements from US hyperscalers like Microsoft, Amazon and Google about creating new availability zones in the country, as well as similar pronouncements from Chinese firms like Alibaba, Tencent and ByteDance,” Beard says.