Lending to data centres – opportunities and risks
Alongside the opportunity they present, there are some potential pitfalls for lenders in relation to data centres and this article explains how conscientious drafting of loan documentation can minimise these risks.
Introduction
With spiralling needs for processing power and storage, most companies are faced with the challenge of how to manage their growing information technology infrastructure. Specialist data centres answer that need, providing both the location and the technical environment to house and manage computing power effectively.
There is an estimated three million data centres in the world today and they can offer an attractive investment opportunity. However, for a potential lender these properties come with a unique set of concerns. Data centres are a specialised form of real estate and the challenges posed by them are distinct from those in the more traditional property investment sector such as the retail and leisure industries. This article sets out some of the potential pitfalls for lenders in relation to data centres and explains how conscientious drafting of loan documentation can minimise these risks.
What is a data centre?
Before considering the potential challenges associated with lending for the acquisition or refinance of data centres, it is important to establish what we are referring to when we discuss data centres.
Essentially, a data centre is a dedicated facility designed to house computing equipment in an optimal environment. Data centres provide the stringent power, communications, cooling and humidity conditions required to run today's servers and high performance computers effectively. These may be purpose built data centres or buildings converted for the purpose, for example in the middle of cities to allow rapid communications with nearby office accommodation.
While the typical image of a data centre is of a factory-sized space filled with computers, the dimensions of data centres can vary from a few servers in a room to huge standalone structures measuring hundreds of thousands of square feet and containing tens of thousands of servers. For perspective, the largest data centre in the world, The Citadel Campus in Northern Nevada, contains an enormous 7.2 million square feet of data centre space.
As well as varying in size, data centres vary in how they are utilised by businesses. Some businesses may choose to have their own in-house data centres. Others will outsource this to one or more data centre providers who house a number of customer's equipment on a shared basis. Public cloud-based services, such as those run by Microsoft and Google, also provide computing power used by a very large customer base from a few very large scale data centres around the world.
Typically, when looking at data centre investments, we are referring to shared centres which manage computing facilities for multiple businesses. These are staffed by a small number of people monitoring a large number of computers and networking devices and ensuring the environment they run in remains stable.
Potential risks and how to mitigate them
The risks associated with data centres are relevant to consider for real estate finance transactions and it is possible for these to be mitigated through careful drafting of finance documentation. In particular, a lender should be aware of the following potential issues:
- Power supply
- Data security
- Co-location businesses
Power supply, communications, heating and cooling
The continuity of power supply is paramount for data centres to run smoothly. While a loss of power for a traditional shop could be incredibly frustrating and result in a few hours of lost business, a loss of power to a data centre could have much wider ramifications and if multiple businesses lose access to their data it could lead to potentially large associated claims and business risks. What is more data centres consume a vast amount of power (even though computing is becoming more energy efficient) and power supply is vital to their operations.
Communications links to the data centre are equally important. Power and communications also need to be distributed from the point of access to the data centre (cables, satellite links etc) through to specific customer racks within the data centre.
In order to mitigate risks associated with power supply, it is vital for the lender to ensure that it has sufficient control over the level and continuity of the data centre's power supply. As well as the usual general obligation to keep the data centre in good repair and condition, the loan agreement should include specific maintenance clauses that expressly cover key infrastructures such as power cables and connections, fibre optic cables and related telecommunications apparatus. It should also include the right for the lender to approve key contracts such as power supply, telecoms and cooling contracts.
If the power contract is maintained by a tenant rather than the borrower landlord, the lender should ensure there are sufficient restrictions on the surrender of leases with these tenants. It is also helpful for the loan agreement to include provisions requiring the borrower to assign the benefits of key contracts in the event of a lease surrender, so as not to leave the data centre without power.
Data security
Data centres need to be highly secure facilities with restricted access. While users may take steps to protect their data including encryption and back-ups, they will be highly sensitive to the security threat of anyone accessing their servers or storage. Customers will also be concerned that physical damage or damage to their data cannot occur.
A breach of a data centre's physical security could result in a claim against a borrower which could impact their ability to repay their loan. Due diligence can be done on actual security measures and governance to review those measures regularly as well as customer terms and the borrower's insurance. It is crucial for a lender to be made alert to a potential breach of security as soon as possible by including notification wording within the loan agreement. This will give the lender the opportunity to understand the risk and take action ideally before any claim is made.
Co-location businesses
Many data centres run on licences to customers with relocation provisions rather than traditional leases. Although by necessity the customer is given specific racks, cabinets or floor space to locate its equipment, the data centre can (in theory at least) move the customer. This is intended to avoid leasehold rights arising.
While many data centres allow colocation within the specific data centre, the key risk with colocation businesses is where contracts allow relocation to a different data centre that the lender does not have security or control over. This would reduce the income to the asset that the lender has security over.
While most data centre owners reserve the right to relocate their customers, in practice this is logistically challenging and costly so is rarely utilised. Therefore, the best approach for a lender concerned about these rights is to restrict the borrower's ability to relocate a customer's racks and equipment without the lender's consent, thus ensuring that sources of income to the data centre cannot be moved elsewhere without the lender's approval. Given that a borrower would be unlikely to relocate its customers this should be easy to agree from a commercial perspective.
How to approach data centre financing
The above examples are just some of the potential ramifications lenders should be aware of when considering lending in data centre transactions. Data centres are a unique asset class within real estate finance that pose a unique set of hurdles. However, with adequate assessment and appropriate drafting in facility agreements and security documentation, it is possible to identify and mitigate these risks in a way which is both commercially acceptable to borrowers and provides adequate security for lenders.
Fieldfisher LLP and data centre transactions
Fieldfisher LLP ranks as a tier one information technology law firm with a broad client base in this sector and our real estate finance team is highly experienced in financing data centres. This combined expertise across our practice groups means we are ideally placed to advise on these transactions and offer guidance on the specific issues associated with them.
If you would like to discuss data centre transactions, please get in touch with your usual Fieldfisher contact.
Real estate finance:
Philip Abbott
Jayne Backett
Christian Francis
Richard Gibbard
Natalie Starr
Technology:
Simon Briskman
James Walsh