Special Report Data Centers: Financing Strategies for Data Centers AUGUST 2010
FINANCING STRATEGIES OVERVIEW Data Center projects present unique financing challenges. The highlyspecialized infrastructure makes data center projects difficult for a company to finance in the current capital markets environment. In addition, the missioncritical nature of these projects often creates a dilemma for a company that needs a high degree of security, future operational control, and is resistant to the idea of third-party ownership. As a result, the default decision is often for the Company to finance the projects with internal capital. The Company s dilemma is that data center projects command significant capital resources that could be better utilized in other areas of the business. With the guidance from experienced financial advisors, some companies have begun to successfully utilize alternative financing methods for data centers. These financial structures meet the need for low-cost, third-party funding coupled with the opportunity for a high degree of ownership control. These financial alternatives include Conduit financing and Synthetic Leases. CONDUIT FINANCING Conduit financing has become an increasingly utilized vehicle for data center facilities and other missioncritical assets. In an effort to attract and retain companies, many states, counties and cities now offer a new form of real estate economic incentive through Conduit ownership and lease offerings. Under these arrangements, a governmental instrumentality Conduit (Port Authority, Redevelopment Agency, or Joint Powers Authority) will finance a new facility for the Company s use, exercising its power to issue longterm lease revenue-backed bond debt. The Company agrees to enter into an Operating Lease with the Conduit for a typical term of 15 to 20 years. Annual base rental obligations charged to the Company are flat (no increases) for the full base term based on a calculation of a pass-through of annual principal and interest on the Conduit s low-cost project financing. The resulting rent incurred by the Company is typically far less than prevailing market rents. Furthermore, there is no limitation on the amount of funding available for specialized building improvements. All building costs can be funded through the Conduit s project debt. Page 2
CONDUIT FINANCING CONTINUED In addition, the Conduit can construct the data center on land owned by the Company, through a Ground Lease from the Company. If the land site is controlled by a third-party owner, the Conduit can acquire the land and gift the land to the Company, then develop the data center on the land through a Ground Lease from the Company. This would allow the Company to: Control future residual value of the data center property (title to the data center building automatically reverts to Company s ownership at the end of the Ground Lease) Take advantage of purchase rights to the data center building that would decline in value over the term of the lease, while still maintaining an Operating Lease outcome for reporting purposes. This benefit is due to the wasting asset nature of buildings on leased land, wherein Fair Market Value actually declines over time. The Company may terminate its lease commitment at any time through either a purchase and resale of the data center to a third party, or by an assignment of its purchase right to a third party, provided that the full remaining balance of the Conduit s project financing is fully repaid. In most state jurisdictions, ownership of the project by a governmental instrumentality Conduit allows an exemption from sales taxes on construction materials and in many cases, partial or full exemption from property taxes. Applications are not limited to design-build projects. A company may also use Conduit financing with sale/ leaseback transactions. In summary, the participating Company receives: Below-market and flat rent costs for the full term of the lease 100% funding of project costs, including specialized improvements Reduced project costs (sales tax exemption) and operating expenses (property tax exemption) Purchase rights to the data center building at a declining option price Automatic future title to the data center building at the conclusion of the Ground Lease Ability to terminate the lease via a purchase and resale or a purchase right assignment Execution of Conduit transactions requires an experienced team of project participants. CBRE has unparalleled expertise in the structuring and management of Conduit transactions and has served as advisor to many of the largest corporate data center users on a global level. Page 3
SYNTHETIC LEASES To paraphrase Mark Twain, reports of the death of the Synthetic Lease have been greatly exaggerated. Following the accounting reforms of 2004 and particularly since the capital markets disruptions starting in 2007, Synthetic Leases have experienced a renaissance. These transactions continue to be the financing vehicle of choice for many data center transactions. Synthetic Leases combine the benefits of very low occupancy costs (rent is equal to interest-only debt service on project financing), short-term lease commitments, purchase rights at original project cost, depreciation benefits for tax purposes, and characteristics of an operating lease. Like the Conduit structure, Synthetic Leases can fund 100% of project costs including highlyspecialized data center improvements. A Synthetic Lease is a leasing arrangement with an unusual combination of features taken from conventional leases and financing transactions. In a Synthetic Lease, a bank lender finances the data center project using interest-only financing. The Company is charged rent based on the interest accrued on the total project costs. The bank underwrites these transactions as if they were a revolving line of credit to the Company which, incidentally, is backed by the real estate asset as collateral. Another benefit is that no Loan-to-Value limitations are imposed on project funding. The lease term is typically five to seven years and at the conclusion of this term, the parties could agree to renew for an additional term or the Company could purchase the property at the original cost financed by the bank. In the event the parties do not exercise either of these options, the property could be sold to a third party. Unlike a conventional leasing arrangement in a Synthetic Lease, the Company, as the Lessee, posts a Residual Value Guarantee to the bank. Which means that the Company takes the risk of the data center property s market value dropping below 89.9% of the figure required to make the bank whole (pay off of the remaining debt balance) in the event of a sale to a third party. The 89.9% limitation is required by GAAP guidelines that allow the company to record the transaction as an Operating Lease. Finally, and in exchange for the corporation s Residual Value Guarantee, the Company receives Tax Ownership of the data center property and is able to claim depreciation benefits for the property otherwise reserved exclusively to property owners. In summary, the participating Company receives: Very low and flat rent expense for the full term of the lease A short-term lease commitment allowing the Company to retain operational agility 100% funding of the data center project costs including specialized improvements A purchase option priced at the original project costs Depreciation benefits for Tax purposes Page 4
SYNTHETIC LEASES CONTINUED CBRE has served as advisor in over one billion dollars of Synthetic Lease transactions since 2005 and has skillfully managed the unique financing, legal, accounting and documentation of these transactions. CONCLUSION Both the Conduit and Synthetic Lease alternatives provide lowcost, third-party financing for data center projects with uncommon benefits in long-term ownership and operational control. FOR MORE INFORMATION, PLEASE CONTACT: Randy Pereira Senior Vice President CB Richard Ellis randy.pereira@cbre.com 602.735.5238 Doug Godard, MCR, LEED AP Senior Vice President CBRE Global Corporate Services doug.godard@cbre.com 614.280.4816 Jerry Reich, LEED AP Managing Director CBRE Global Knowledge Network/ Critical Environments jerry.reich@cbre.com 202.585.5670 Page 5
ABOUT THE AUTHOR Randy Pereira Randy Pereira, a senior vice president at CB Richard Ellis, provides real estate portfolio financial advisory services to a client base consisting of prominent corporations and public entities. These activities encompass the development, design and execution of portfolio financial strategies that are well-aligned with the overarching financial and operational objectives of the client organization. During his 25 year career in finance, Mr. Pereira has served as advisor in some of the real estate industry s most prominent transactions, and has gained national recognition from organizations such as Standard & Poor s for his skill at managing the complex blend of Legal, GAAP, Tax, FASB, Rating Agency and regulatory issues that accompany highly-structured transactions. www.cbre.com/randy.pereira ABOUT TEAM MEMBERS Doug J. Godard, MCR, LEED AP Doug Godard is a Senior Vice President in the Technology Practice Group with CB Richard Ellis, Inc. For over 26 years, Doug has continued to assist clients with the optimization of their corporate real estate portfolios, assist clients with data center solutions and design/build projects. Doug is a registered lobbyist in the State of Ohio and is a LEED Accredited Professional. www.cbre.com/doug.godard Jerry Reich, LEED AP As the Global Knowledge Network Practice Leader for Critical Environments, Jerry is responsible for the organization and leadership for the Americas working in partnership with his counterparts of EMEA and APAC. Jerry has over 23 years of global project management and owners representation experience as a result of managing projects and project teams throughout the US, Canada, South America, Europe, South Africa and Asia Minor. His broad range of project experience includes general administrative offices, ground-up property development, Tier IV data centers, top secret facilities, as well as healthcare and bio-tech centers. Jerry is a LEED Accredited Professional. www.cbre.com/jerry.reich ABOUT CB RICHARD ELLIS CB Richard Ellis Group, Inc. (NYSE:CBG), a Fortune 500 and S&P 500 company headquartered in Los Angeles, is the world s largest commercial real estate services firm (in terms of 2009 revenue). The Company has approximately 29,000 employees (excluding affiliates), and serves real estate owners, investors and occupiers through more than 300 offices (excluding affiliates) worldwide. CB Richard Ellis offers strategic advice and execution for property sales and leasing; corporate services; property, facilities and project management; mortgage banking; appraisal and valuation; development services; investment management; and research and consulting. Please visit our Web site at www.cbre.com 2010 CB Richard Ellis, Inc. CB Richard Ellis statistics contained herein may represent a different data set than that used to generate National Vacancy and Availability Index statistics published by CB Richard Ellis Corporate Communications Department or CB Richard Ellis research and econometric forecasting unit, CB Richard Ellis Econometric Advisors. Information herein has been obtained from sources believed reliable. While we do not doubt its accuracy, we have not verified it and make no guarantee, warranty or representation about it. It is your responsibility to independently confirm its accuracy and completeness. Any projections, opinions, assumptions or estimates used are for example only and do not represent the current or future performance of the market. This information is designed exclusively for use by CB Richard Ellis clients, and cannot be reproduced without prior written permission of CB Richard Ellis. Page 6