As published in The Urban Developer (opens a new window).
Increased demand
With the growing use of and need for technology, data centres have become vital in providing digital connectivity through data processing, storage, and computational services, which are crucial for modern life, businesses, and economic growth.
This heightened demand makes data centres a wise investment for property owners and developers.
Data centres typically face high barriers to entry because they need access to substantial power to operate and rely upon predictable revenue through medium to long-term contracts.
Like traditional real estate, their performance as an investment greatly depends on location but also on access to power and supply.
Investors focused on data centres typically invest in one of the following ways:
Some purchase land, then sell or lease it to data centre developers.
Others partially develop data centres before selling the facility to either developers or end customers.
Whilst others will buy the land, build the facility, ensure power and connectivity, and finish the interior. This co-location model often results in leases to ‘enterprises’ or ‘hyperscalers’ (companies that manage large-scale data centres, such as ‘cloud’ operators).
The above highlights the significance of investing in data centres - they bring huge revenue opportunities. However, with such varying risk factors and logistics, much needs to be considered.
The ideal data centre formula - what to consider
Investing in data centres can be rewarding as they offer great revenue potential.
However, various risks and logistics must be carefully evaluated (such as fragile operating environments, high value equipment, power availability, supply chain issues, and natural disasters).
If managed well, this can lead to better tenancy increases and higher chances of tenant renewals.
Owners with the right expertise and resources will be better placed to handle these risks and maintain a strong position in this specific area within the property sector.
Risks for consideration:
Development/Construction Risks –
Data centre developers should not only ensure standard construction insurance is in place but also account for long lead times on critical equipment like chillers, ventilation, air conditioners, and standby generators.
This specialised equipment is often in high demand, and if it's lost or damaged, it can take time to replace.
Any damage during transport can also delay project timelines. Meeting agreed debt repayment dates is crucial to avoid extra costs and damage to reputation.
Fire and Environmental Risks –
Fire, flooding, and natural disasters (like earthquakes or storms) pose significant threats to data centres.
Traditional fire suppression systems cannot be utilised in data centres due to their reliance on water and the risks this would present to damaging sensitive electronic equipment.
Robust measures must be implemented to suppress fires effectively while minimising risk to the critical infrastructure that keeps data centres operational.
This results in additional planning and costs to ensure the appropriate infrastructure is in place and how insurance policies are designed to respond following a loss event.
Given the high cost of equipment and potential data loss, insurers may require advanced fire suppression and environmental controls be in place.
Data centres can also impact the environment due to their high power and water usage. This significant resource demand can threaten the surrounding natural environment.
Operators of retrofit data centres should consider their location not only in relation to nearby tenants but also regarding environmental risks.
Power Supply Risks –
A continuous energy supply is essential for data centres including storage equipment, cooling systems, and monitoring tools.
Power reliability is crucial to avoid potential liabilities from outages.
Power purchase agreements (PPAs) offer stability for buyers and sellers while shielding them from price fluctuations.
Backup power systems can keep data centres operational temporarily during unexpected outages, but it’s crucial to determine who will pay for additional replacement power.
Many data centres depend on local power supplies, which can pose political or security risks if reliability decreases and affects local communities.
While grid blackouts are infrequent, energy organisations often struggle to find coverage for outages.
Owners and developers need to understand the risks involved. If the power source fails, is there a backup plan, what are the costs and are there other unforeseen consequences?
Business Interruption Risks –
Business interruption costs from loss-of-income scenarios are a major concern for insurers regarding data centres.
Such situations can occur when tenants seek relief under their contracts with data centre owners, which may lead to renegotiation of terms.
A key risk for business interruption is an inconsistent or interrupted energy supply, which can result in tenant losses. While tenants are typically responsible for their data server maintenance, a power failure affecting monitoring or cooling systems can increase fire risks and cause damage to equipment.
This could lead to data loss and disrupt operations. Some servers also have automatic shutoff protocols that activate if cooling systems fail, potentially allowing tenants to break their contracts.
Cyber & Technology Risks –
Data centres are susceptible to data breaches and cyber events with varying entry points for harm and disruption to occur.
For instance, if a hacker targets the cooling system in a server room, it might cause the servers to overheat and fail. This can create fire hazards and disrupt business operations, leading to costly repairs for the cooling system and servers. Resulting in a chain reaction of serious issues.
Disruption to power feeds can have similar consequences. When data centres go offline, they can suffer costly service interruptions, damage to hardware, loss of customer data, and potential lawsuits.
Each device and access point increases the risk of unauthorised access, which can impact operational conditions like temperature, humidity, and voltage.
Such incidents can breach contractual obligations, leading to loss of clients/customers, revenue, and can harm the centre’s reputation.
Equipment Failure Risks -
The risk of mechanical or power failures leading to outages is a major concern. Redundancy measures (e.g., backup power systems) are often reviewed by insurers as measures to mitigate these risks.
Physical Security Risks -
Data centres are vulnerable to theft or sabotage, so insurers assess the facility's physical security, including access control, surveillance, and on-site protection.
Insurers’ reaction
Insurance companies typically view data centres as high-risk facilities due to the critical nature of their operations and the potential for significant financial losses if something goes wrong.
That said, data centres with robust risk management strategies, including redundancy, fire suppression, and strong cyber-security, tend to receive more favorable insurance terms, whilst those lacking safeguards may face higher premiums or more limited coverage.
Conclusion
It is essential for investors in this asset class to collaborate with partners who understand the unique risks in this sector and can provide expert advice before acquisition or development, helping to ensure those risks are properly managed.
The contents of this publication are provided for general information only. Lockton arranges the insurance and is not the insurer. Whilst the content contributors have taken reasonable care in compiling the information presented, we do not warrant that the information is correct. It is not intended to be interpreted as advice on which you should rely and may not necessarily be suitable for you. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content in this publication.
