JONES DAY TALKS®: Real Assets Roundup Episode 2: A First Look at Data Centers: The Fourth Utility

We hope you enjoyed episode one of Jones Day's Real Assets Roundup. The response and feedback were great, and if you haven't heard it, please visit the link provided and be sure to subscribe to the series. In this program, Brian Sedlec and his Jones Day panel talk about what's being described as the fourth utility, digital assets infrastructure. Water, gas, electricity, digital infrastructure. It shows just how important that fourth utility will be to industry, finance, transportation, government, and society as a whole. Brian and Company will drill down and explain, so keep it here. I'm Dave Dalton. You're listening to JONES DAY TALKS®.

Brian Sedlak:

Well, welcome to episode two of the Real Assets Roundup, where we focus this time on digital infrastructure assets. I'm Brian Sedlak, co-lead of the real estate, energy transition and infrastructure practices at Jones Day. Go to episode one if you'd like to hear more about the definition of real assets or a little bit more about this podcast.

Today, we are on location in Columbus, Ohio, and I'm joined by Melissa Vandewater, Liz Yaeger and Marta Lahuerta Escolano, so welcome. Marta, before we begin, I would like your views, your initial impressions of Columbus. You came directly from Paris, you came off the plane, you've had a chance to see some things. Tell us about what you think about Columbus so far.

Marta Lahuerta Escolano:

Columbus is a lovely city. Unfortunately, I didn't have the time to visit the great spots that I've been told about, but definitely tonight, I will have the time to do it.

Brian Sedlak:

That's great, and Columbus has some great cultural assets, great museums, a fantastic zoo. If you have a chance, go to the zoo. It's too bad that you're going to go home before the state fair next week, but maybe you can come back and visit at some point. Maybe you guys could each introduce yourself and say a little bit about what your practice is before we begin. So Melissa, why don't we start with you?

Melissa Vandewater:

Thanks, Brian. It's great to be here. I'm Melissa Vandewater. I'm a partner in the Chicago office of Jones Day. My practice is real estate, but I have a big focus in digital infrastructure. It really is an asset class that's been busy with real estate work along with other interdisciplinary aspects, and I'm excited to talk about the digital infrastructure asset class today.

Brian Sedlak:

Liz, why don't you introduce yourself?

Liz Yaeger:

Hey, everybody. Liz Yeager. I am a resident of the DC office partner in real estate. For the last 12, 13 years, I've been practicing real estate, and out of those 13 years, probably about the last five focusing on digital infrastructure. Currently, my practice is about 90, 95% of representing operators in build to suit leases with hyperscalers.

Brian Sedlak:

That's great, Liz. Marta, why don't you tell us a little bit about yourself?

Marta Lahuerta Escolano:

Thank you, Brian. I'm Marta Lahuerta Escolano. I'm a partner based in the Paris office, and I've spent the past 14 years specializing in digital infrastructure transactions on a global scale. So my experiences encompasses a broad range of digital infrastructure assets that include data centers, subsea cables, fiber optic cables and satellites.

Brian Sedlak:

That's great, Marta. So Melissa, if we just surprised you and asked you this question, are you a real estate lawyer or are you an infrastructure lawyer? Are you both? Do you have a view on that?

Melissa Vandewater:

Really both. That's such a good question. I would say both. at its core, data centers are real estate assets, but because of the digital infrastructure world, it really touches everything from the utility improvements to the software, so it's very much an integrated system of infrastructure.

Brian Sedlak:

As long as we're on that topic, Melissa, why don't you describe digital infrastructure and what it encompasses?

Melissa Vandewater:

Sure. Digital infrastructure assets really are the physical assets that provide and support digital communication, networking, data transfer and storage, and really online services. They enable everything from internet access and cloud computing to advanced technologies like AI. The assets as part of digital infrastructure are really crucial for businesses, government and society as a whole, then they facilitate economic growth, innovation and access to essential services.

As I heard you say, Brian, in episode one, they are really now thought of as the fourth utility next to water and electricity, and they've really become a key component of modern society. They include data centers like we've talked about, which really house and store not only the power and cooling infrastructure and equipment, but also servers and networking equipment that help to store process and distribute the vast amount of data. Networking equipment as well, router switches, firewalls and fire optic networks, underground and subsea cables, communication towers, cell towers that really provide for wireless communication, and even things like the internet of things. So devices that really collect and store data for specific purposes. Think nest thermostats or smartwatch fitness apps reminding you to get up and take a break and take some steps around the block, for example, after a busy workday. So really, everything that's part of our communications network.

Brian Sedlak:

Well, that's great, and I know, Marta, you do a lot with respect to subsea cables, but it seems like data centers are really the things that you see most in the newspaper practically every day, so maybe we can spend a few minutes and just drill down a little bit on data centers. Why don't you explain to folks what they consist of, maybe who's interested in them, who owns them, who uses them? I know there's not one set rule, but maybe you can speak in some generalities.

Marta Lahuerta Escolano:

Yes. So a data center is basically a large secure building or facility that's filled with racks or servers, storage systems and networking gear. So these centers, they have powerful cooling systems to keep everything from overheating, backup power supplies in case of outages, and tight security to protect the data and equipment. So basically, the main job of a data center is to store, process and manage huge amounts of data. They make sure that the websites, applications, cloud services, and even things like for example streaming videos or online banking work reliably and quickly.

You can also think of a data center as having two main parts, an internal part, an external part. The internal part of a data center is made up to two major components, the computer part and the technical infrastructure, and externally, data centers, they're heavily dependent on energy operators for electricity production and they're also dependent on telecom operators.

Brian Sedlak:

And so in terms of the typical data center, what type of entities own them or invest in them? What kind of entities use them? Do you have thoughts on that?

Marta Lahuerta Escolano:

Data centers, they can be owned by a variety of players. Some of the biggest ones are large tech companies such as Amazon, Google and Microsoft, so they build their own massive data centers.

Brian Sedlak:

Is that what's called hyperscalers? Sorry.

Marta Lahuerta Escolano:

Hyperscalers, exactly. Yes, that's exactly that. So they build their own massive data centers to power their cloud services and platforms, and they are also specialized companies that they're called colocation providers that build and operate data centers, and then they rent out the space, power and network connections to other businesses. Telecom companies, sometimes they own data centers too, and increasingly, investment funds and infrastructure specialists are buying or building data centers because they see them as a valuable long-term assets.

As for who uses the data centers, the customers base is really broad. Cloud service providers like Amazon and Microsoft are big users, but so are banks, insurance companies, retailers and manufacturers. Basically, any large business that needs to keep its data safe and digital services running. Many companies like streaming platforms and social networks rely on data centers to deliver content for millions of users, and also governments and public agencies use them to host sensitive data.

Brian Sedlak:

Okay. So Liz, I want to kick it over to you now. In terms of the US, who are the likely, and you don't have to give names, but what's the profile of a typical data center owner if it's not a hyperscaler? What does that look like?

Liz Yaeger:

These are data center operators that function to either build large data centers for hyperscalers or have colocation facilities, a multitude of tenants who are in one facility and the operator provides the services of interconnecting the infrastructure so that those particular businesses can run out of the cloud, et cetera, to then go use the services of the hyperscalers. Two variations, right? Either the data center provides services to the hyperscaler or provides services to the various businesses that then go to the hyperscalers to use their services, like cloud services.

Brian Sedlak:

So I know you've been in this area a long time, but maybe you can describe for our listeners. In essence, what's the big deal? What's driving all of this? Why are folks all of a sudden so interested in it and why every day when I open up the paper because I'm one of the last people in the world who actually reads a physical newspaper, why is there an article regarding data centers or digital infrastructure?

Liz Yaeger:

The reality is that the COVID years really revolutionized the data consumption. It spurred cloud computing, AI, edge computing, and ultimately resulted in a global digital transformation, so there's really a great output and consumption of data. With that happening, that means that you need more power. More power needs to be generated to fuel all our uses and our output. So really, the big deal is that we have larger energy needs and those larger energy needs currently cannot be met by the utilities or the grid, so we're looking at alternate sources of power that is reliable, cheaper, and also power that can be harnessed at greater amounts to deal with the AI training models that are required for the output and consumption that we're talking about.

Brian Sedlak:

In terms of these assets, are they real estate or are they infrastructure? How is that looked at in the market?

Liz Yaeger:

Yeah, I would say it's a combination of both. You have infra funds and real estate funds investing in the same sort of projects, so really, the industries are looking at it as just an investment opportunity, both from a real estate, traditional real estate perspective and an infrastructure perspective. In addition, you have more than one PE platform and its own infra and RE funds investing in the same investments side by side.

Now, in terms of financing the data centers, you have lenders looking at it from a project finance perspective, from a traditional real estate perspective, and those models are in line with who the tenants are and the sorts of revenues that are generated by these data centers. From a project finance perspective, because the tenants in a hyperscale lease are so credit worthy, these are some of the most credit worthy entities, you really are financing the revenue generated from those leases. Now, from a commercial real estate perspective, you're looking at the asset itself along with the credit worthiness of the operator or would be the borrower.

Brian Sedlak:

So in terms of these sites, it seems like Virginia, Chicago, the Dakotas now folks are interested in. What's the other major location in the US where these sites are typically located? I know I'm missing one here.

Liz Yaeger:

Ohio, absolutely. We're sitting here. Pennsylvania, Atlanta, we talked about Northern Virginia, Texas, all those areas are really booming right now. There's a lot of data center development, massive AI projects, data center campuses that are over a gig.

Brian Sedlak:

And why do you think there's been a recent siting of these facilities in places like Ohio and Pennsylvania? Just this week, there was announced by a large fund, there's going to be an $85 million investment in Pennsylvania, part of which they'll contribute and part of which they'll catalyze. But from your perspective, what makes a good data center site? What are the attributes and why are folks looking in the locations that they're looking?

Liz Yaeger:

Yeah, a few different things. Because the utilities can't keep up with demand, we're looking at secondary and tertiary markets that have natural resources available to them that can provide the kinds of power that we talked about earlier, so there's that aspect. There's also tax incentives. Any incentives that the local jurisdictions can provide will naturally attract the operators, the hyperscalers to that. The labor market, is there sufficient labor to construct the data center sites? Those are all things that go into consideration. I talked about natural resources, not just from a water perspective, but from natural gas, coal, nuclear, et cetera. All of that paints a really great picture for the perfect site.

Brian Sedlak:

So it's part energy, reliability, resiliency, availability. That makes a lot of sense. Marta, in terms of Europe or Africa or the Middle East, any general rule in terms of how they're different than the US?

Marta Lahuerta Escolano:

One of the most significant differences in Europe is Europe's strong emphasis in sustainable low carbon energy for data centers. France is a great example because they benefit from a highly decarbonized electricity grid, mainly due to the nuclear and renewables, which is a decisive advantage for attracting large scale data center investments. So European regulators, they're increasingly focused on the integration of data centers into broader climate goals. And on the other hand, with respect to land availability, European markets, they face greater constraints around land availability, especially in densely populated regions. The regulatory environment is also more complex with stricter planning and environmental requirements.

Brian Sedlak:

Why don't we focus in terms of if you look into your crystal balls, what keeps you up at night in terms of what you worry about when representing a data center owner or digital infrastructure investor? Maybe Melissa, you can say a few words about DeepSeek and whether that has impacted investment, and maybe talk a little bit about the challenges of development and risks and the like.

Melissa Vandewater:

Yeah, it's definitely those potential disruptors that keep us up at night and our clients up at night, DeepSeek being one of them. The announcement there earlier in January of this year that this startup in China came up with an AI model that was done at a cost advantage with less power requirements definitely threw our stock market here in the US for a spin. Initially, our clients were uncertain certainly what this effect would be long-term, but in the last six months, we're still very much busy with AI developments and really our clients are viewing this as an opportunity. This particular industry has to be nimble because innovation really created this industry and will continue to cause evolution in this industry, so we need to be nimble and reacting to innovation. We've seen that with DeepSeek where maybe there's potential AI modeling for training type facilities, but that might change. But still, once trained, the AI inferencing sites will still require data, still driving the need for digital infrastructure including data centers. Clients still remain optimistic.

Brian Sedlak:

What I've seen in my 33rd year as a lawyer, when there tends to be a less expensive or less sophisticated version of something, it really doesn't eliminate demand. Quite frankly, I find that it creates demand because then technology gets involved in more items and people want more, and then that requires an ever-increasing sophisticated chip or model. So I think in the end, it will likely affect the landscape but probably doesn't affect the industry long-term.

In terms of some of the challenges with respect to these sites, Liz, maybe you can talk from a lender's perspective and what they're thinking about, they're trying to cover in terms of risk, or what happens at the end of the term of these long-term agreements? Maybe they don't worry about it too much because of the length, but maybe you can give some insight there.

Liz Yaeger:

Yeah, absolutely. So the reality is that what we're thinking about the lease paper that these, I'm going to focus on hyperscale leases that they're written on, the hyperscale leases are extraordinarily favorable to the tenant, and so we have a lot of termination rights for not just a failure to deliver, for termination for convenience provisions, termination for failure to deliver certain service levels. So there's a huge risk. There's upfront risk but also risk throughout the operational life of the data center. Along with that, built into these contracts, into these leases are very strict transfer restrictions, including for foreclosure. So when the lender steps in, they really have to negotiate very strong NDAs to provide for the lender taking over in the event of a foreclosure so that the lender's ownership is recognized and respected, and all of that needs to be built in the SNDA, and that happens most of the time after the lease has been executed. So there's contentious negotiations that happen. We've moved the market further along where these terms are more acceptable, but it's still a battle when you're negotiating that SNDA.

Brian Sedlak:

And I think that's one of the great things about what you and Melissa and Marta do. You're really experts in this area and you help clients navigate these risks seamlessly, so I know that your long history in this area has been very helpful. Marta, in terms of Europe, are the risks any different do you think?

Marta Lahuerta Escolano:

Actually, with respect to hyperscalers, they are actually exporting the same model to other regions of the world where they are expanding their activities. So the main risk and issues that Liz just explained, we have seen them on hyperscaler deals in Europe, in Africa, or in the Middle East.

Liz Yaeger:

I will say though that there's a lot of stickiness with these tenants. The minute that you're able to deliver, it becomes on a practical perspective very difficult for them to actually vacate to terminate the lease. So really, the initial delivery is I think the highest risk point. Once you've gotten past that, it's far easier to refinance, et cetera. The risk goes down because the tenants don't want to move out.

Brian Sedlak:

Melissa and Liz, would you say at this point, the procurement of energy at a particular time on schedule is one of the major issues affecting these developments?

Melissa Vandewater:

Yes. I think with power availability constraints, that's almost the primary issue facing developments being delivered, particularly according to hyperscaler requirements. I think hyperscalers expect to really engage with data center operators and developers because of the speed to market, their promises of a particular schedule, and delivery on schedule. When it comes to procuring power, the developer doesn't really get that level of certainty from utilities. Utilities just don't promise necessarily to deliver by a milestone date, or if they do, there's really no potential recourse available to a developer that would equate to the exposure to your hyperscalers under your agreement. So that is definitely a risk factor in driving our clients to really consider how our documents go back to back and then potential gaps in risk and how to potentially mitigate.

Marta Lahuerta Escolano:

Having in mind these challenges, these land and power challenges, some of our clients, at least in Europe, they may be asking the following key question. That is would it be more valuable to own real estate or to free up the capital to invest in power infrastructures, in cooling technologies and next generation AI developments? And that's why in Europe, we expect that there will be some sale and lease back transactions in data centers.

Brian Sedlak:

So I know it's our goal here on The Roundup to really not go much over 20 minutes. I think we're at that mark, so maybe that's a good place to stop. Since energy seems to be the long pole in the tent for these projects and is really the thing that's impacting siting and developments, maybe that's a good thing to save for next time. We're probably all going to London, right? We're packing up the bus and going to London for a presentation in September, September 16th. So maybe we can get part of this group back together and have some of our energy lawyers join us and talk about energy, because it seems like energy is data and data is energy. For more information, please visit Jonesday.com, and remember to subscribe to JONES DAY TALKS®, The Real Assets Roundup to get advanced access to each episode of the Real Assets Roundup and special subscriber only content. So this wraps up episode two of the Real Assets Roundup, and we hope to be speaking to you again no later than September.

Dave Dalton:

Thanks, Brian. We'll actually be coming to you earlier than expected with a breaking news episode covering the One Big Beautiful Bill, so be on the lookout for that. For complete bios, visit Jonesday.com. While you're there, check out our insights page for our podcasts, publications, videos, and other timely content. Subscribe to JONES DAY TALKS® at Apple Podcasts and wherever else quality podcast content is found. JONES DAY TALKS® is produced by Tom Kondilas. I'm Dave Dalton. We'll talk to you next time.

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