Data Center Construction Costs are Likely to Rise

By David Gross

I've been looking at data center capital costs, and it seems like there's only one direction they can go: up.  Here's why:

1. Cap Labor Costs Increasing Faster than Inflation

Operating labor costs are not much of a factor in data centers.   Microsoft's (MSFT) creating 25 permanent jobs on a $100 million capital outlay in West Des Moines, Facebook's creating 35 on a $188 million outlay in Prineville, Oregon.   Most automated factories produce about one recurring job per $600,000-$800,000 of capital investment, so the one per $4 million - $6 million we see in the data center industry gives you hints as to why there's a jobless recovery.    But where's that all capital going?

On their last earnings call DuPont Fabros (DFT) claimed that 50% of construction cost is labor.   This is a company that did $200 million of revenue last year with just 70 full-time operating employees.   And Facebook might need just 35 to run Prineville, but over 600 have worked on constructing the place, including 225 at any time, according to this article at OregonLive.com. Another glaring example of the gap between construction employment and recurring jobs is the new NSA facility in Utah, which will create up to 4,000 construction jobs, but just 200 permanent jobs at a 1.2 million square foot facility.   A lively work site will likely become an eery chamber of HVAC sounds once it goes into operation.

Construction personnel per square foot varies, but a typical co-lo or do-it-yourself facility goes up with about one construction worker per about 800 feet, same as it was about ten years ago based on data I'm still going through.  If this in fact turns out to be conclusive, it's an issue because cap labor costs have been rising about 5-7%, per year, which has been very noticeable in taxpayer-funded road and transit projects, in addition to the rising capital cost per Megawatt of new power plants, a good portion of which comes from rising health care and benefit costs.    This means that the 50% for labor DFT cited last quarter could very well rise over the next few years.

2. Power Costs are Increasing

Like cap labor costs, power is not getting any cheaper, whether buying diesel generators for backup, or paying by the kWh from the utility, whose own costs are going up.   Solar prices are an exception, and i/o Data Centers has taken advantage that by installing photovoltaics on the roof of their Phoenix facility.   But the capital costs of power equipment show no signs of decreasing.

3. Server Costs Per Square Foot are Increasing

Outfitting a data center with servers is getting more expensive on a per square foot basis, even though the price/performance is improving.   Rackspace (RAX), for example, has been spending about $5,300 per in-service server, including a loading factor for network equipment and firewalls.   But it now has .36 servers per foot, compared to .29 servers three years ago, so its per foot capital cost for customer equipment has risen from around $1,530 to over $1,900, or about 7% per year.

4. Interest Rates are Likely to Rise

I've heard the claim that the credit crunch made it virtually impossible to finance a data center over the last two years.   However, not only is this false, as Digital Realty (DLR), DuPont Fabros, Coresite (COR), i/o Data Centers, Equinix (EQIX), and others have kept expanding, this new construction has been financed at much lower interest rates than often seen when there's plenty of credit.

Equinix, for example, was borrowing at 13% during the dot com boom in 2000.   March 2000 was one of the easiest times to raise money for a technology company, but during that month Colo.com had to borrow at nearly 14%.   Meanwhile, in the depths of the recession in June 2009, Equinix issued $250 million of notes at 4.75%.

While construction costs are not likely to shoot up dramatically, there are very clear trends that will likely push them up over the next few years at a rate faster than inflation, and could be amplified if an economic recovery increases capital labor costs and interest rates.   The time to build is now.