PGIM Real Estate: How data centres are becoming critical infrastructure

May 3, 2023

Demand for data centres, i.e., buildings designed specifically to house computer systems and network equipment, has grown significantly in recent years, underpinned by a host of factors.

PGIM Real Estate’s Morgan Laughlin, Head of Global Data Centre Investments, and Dr. Cuong Nguyen, Head of Asia Pacific Investment Research, explore the key underlying driver of data centre demand – the information, communication and technology (ICT) sector. Based on current structural trends, we believe this sector will continue to grow significantly in the coming years.

The public cloud services market is forecast to grow globally by approximately 20% to reach almost $600 billion in 20231, and cloud data centres are expected to remain the main growth driver in data-centre IP traffic, given strong underlying needs from areas like e-commerce, artificial intelligence, and the metaverse.

Demand for data globally is only going to grow and, as we create more data, we’ll need more processing power to meet this demand. To do this cost-efficiently and in a more environmentally-friendly manner, development of more modern, hyperscale, data-centre capacity is inevitable. And strong tenant-demand forecasts for data centres come from the vital role they play in a technology-driven world.

Strong structural demand has been met with significant investment activity in the sector, rapidly driving new supply. Data centre supply rose 20% per year between 2016 and 2021, led by the Asia Pacific (APAC) region, which saw supply grow 30% per year over the same period3. Growth was particularly strong during 2018 and 2019, when development rose sharply as the region played catch-up to the more mature US market.

Looking ahead, global supply growth is expected to moderate to 13% per year over the next three years due to the cyclical slowdown in economic activity and the large rise in construction costs. The supply pipeline in APAC is also expected to moderate, though certain markets such as Sydney and Tokyo will remain focal points of capacity growth over the next few years. Strong activity tends to be seen in high-population-density markets, with less-developed data-centre infrastructure but better land and power availability, where cloud operators set up facilities to complement those in major metros nearby4.

The present global market instability and likely economic downturn will undoubtedly have some dampening effects on the rate of data-centre demand growth, but it is expected to remain relatively strong relative to other real-estate sectors. With data centres increasingly becoming critical infrastructure to keep economies working, we see investment returns rebounding ahead on a global basis, reflecting the global need and demonstrating the sector’s resilience to short-term market forces.

Going forward, the return outlook across the three major markets – the U.S, Europe and APAC – tells a similar story – a softer near-term outlook to yields, as the economic environment weakens, before recovering ahead of expected improving economic fundamentals in 2024.

There is the risk that with construction costs, including those associated with environmental goals, potentially limiting supply, global rental growth is likely to increase more than expected, driving returns higher.

Concerns about energy usage and its impact on the environment have forced the industry to take stock and look for ways to meet sustainability goals. In response, hyperscale tenants and operators have voiced a strong commitment to a zero-carbon footprint and to using renewable energy to operate their facilities.

Carbon emission in data processing is driven by the number of servers running and the total energy required to power and cool the servers. Customers would use fewer servers and less power by using cloud computing instead of operating their own enterprise solutions; so a shift from enterprise to cloud dramatically reduces carbon emissions. Data centres will therefore have to optimise the use of resources and find the most energy-efficient way to meet future digital demands.