Demand for data center capacity has soared in recent years, driven by rapid growth in data. This trend accelerated during the pandemic as more people worked from home and streamed content over the internet. As a result, the industry completed a record number of new data centers last year.
However, 2022 could be a different story. While demand for data infrastructure isn't slowing, the industry is starting to feel the impact of global supply chain issues. That could hamper the sector's growth prospects by causing delays and rising costs.
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Troubles ahead
CBRE's 2022 data center real estate outlook noted that potential supply chain interruptions could impact the sector this year. It highlighted several issues, including pandemic-related restrictions in Asia-Pacific, material shortages, and increased shipping delays to U.S. ports, which could delay new data center development and impact the refresh cycles of existing data centers.
These issues will drive up costs for data center operators. However, they do have some pricing power, which should enable them to pass these costs through to customers. CRBE sees rents rising 4% to 6% in some markets to help offset these headwinds.
How the industry is responding to these challenges
While the global supply chain issues are a potential problem for the data center industry, most operators have taken a proactive approach to help mute the effect. Leading data center REIT Digital Realty (NYSE:DLR) discussed the industry's supply chain issues on its fourth-quarter conference call. CEO Bill Stein stated:
We are seeing some effects on the supply chain. Clearly, most of the equipment is strained in terms of availability, including data center infrastructure, servers, and network gear, and shortages in things like chips and fans are impacting many industries, not just ours.
However, Digital Realty has overcome some of these disruptions through its vendor-managed inventory program that manages vendors and forecasts its needs. This program has given it a priority for production slots with its suppliers, allowing it to reduce lead times by 70% compared to the standard. It has also worked closely with customers to order their gear early to lock in pricing and avoid shipping delays.
Fellow data center REIT Equinix (NASDAQ:EQIX) has a similar strategy that's helping mute the impact of supply chain-related issues. On its fourth-quarter conference call, CFO Keith Taylor stated:
We've invested heavily in a sophisticated and forward-leaning procurement and strategic sourcing organization, allowing us to execute against a robust development pipeline across our platform while continuing to deliver against our return expectations. This is not to say there isn't congestion in the supply chain, but we feel very well placed with our partners and suppliers, resulting in limited delays against our expectations. To highlight that point, in the fourth quarter alone, we added 17 new projects to our IBX and xScale build program across 14 separate markets, while we completed seven projects across six markets.
Meanwhile, smaller data center operators are also taking steps to address the industry's headwinds. For example, Switch (NYSE:SWCH) started designing its own custom equipment. That ensured the company wasn't competing for the same manufacturing production slots as larger players.
Another approach smaller players have taken is to join forces with a larger entity to increase their scale, giving them more purchasing power to address the sector's headwinds. Two data center REITs agreed to acquisitions by large private equity funds, while another merged with a larger communications infrastructure REIT. Meanwhile, Equinix and Digital Realty have acquired smaller data center operators in Africa over the past few months. This consolidation trend could force other smaller data center operators to combine with a larger rival so they can benefit from their purchasing power to offset the impact of supply chain issues.
A potentially challenging year for the sector
Supply chain issues have already started weighing on data center operators this year. Shares of data center REITs tumbled double digits last month due in part to this headwind. However, while 2022 could be more challenging for the sector, especially for smaller data center players, the long-term outlook remains bright due to the rapid increase in data usage. Because of that, the industry remains a compelling one for real estate investors over the long term.
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