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What lenders should know before financing data centres

Jayne Backett, banking partner with law firm Fieldfisher, says debt providers need to consider the unique risks of financing data centres.

Data centres have been an attractive alternative real estate asset class for a several years, and the covid-19 pandemic has amplified interest in them as the property industry gets to grips with what the future may hold for more traditional commercial real estate like offices, retail and hotels.

Jayne Backett

Data centres are dedicated facilities containing computing equipment that collects, stores, processes and distributes data. Dimensions can vary from a few servers in a room to huge standalone structures measuring hundreds of thousands of square feet and containing tens of thousands of servers. The largest data centre in the world, The Citadel Campus in northern Nevada, contains 7.2 million square feet of space, equivalent to 94 football pitches.

However, to a potential lender, these properties come with a unique set of concerns. The risks associated with data centres are atypical for most real estate finance transactions and a lender should be aware of power supply, data security and co-location businesses when structuring any loan agreement. There are potential pitfalls for lenders, but conscientious drafting of loan documentation can minimise these risks.

Continuity of power supply is paramount. Loss of power to a data centre could mean multiple businesses lose access to their data, leading to potential claims. It is vital for a lender to ensure it has sufficient control over the level and continuity of the data centre’s power supply.

Communication links to the data centre are equally important. As well as the usual general obligation to keep the data centre in good repair and condition, the loan agreement should include specific maintenance clauses that expressly cover key infrastructures such as power cables and connections, fibre optic cables and related telecommunications apparatus. It should also include the right for the lender to approve key contracts such as power supply, telecoms and cooling contracts.

Data centres need to be highly secure facilities with restricted access. Businesses will be highly sensitive to the security threat of anyone accessing their servers or storage. Customers will also be concerned that physical damage or damage to their data cannot occur. Due diligence can be done on actual security measures and governance to review those measures regularly as well as checking the customer’s terms and the borrower’s insurance.

A breach of a data centre’s physical security could result in a claim against a borrower, which could impact their ability to repay their loan. It is crucial for a lender to be informed of a potential breach of security as soon as possible by including notification wording within the loan agreement.

Many data centres run on licences to customers with relocation provisions rather than traditional leases. Although, by necessity, the customer is given specific racks, cabinets or floor space to locate its equipment, the data centre can move the customer. This is intended to avoid leasehold rights arising.

While many data centres allow co-location within the specific data centre, the key risk with co-location businesses is where contracts allow relocation to a different data centre that the lender does not have security or control over. This would reduce the income to the asset that the lender has security over.

While most data centre owners reserve the right to relocate their customers, in practice this is logistically challenging and costly so is rarely utilised. Therefore, the best approach for a lender concerned about these rights is to restrict the borrower’s ability to conduct a co-location business without the lender’s consent, thus ensuring that sources of income to the data centre cannot be moved elsewhere without the lender’s approval.

Data centres are a unique asset class within real estate finance that pose a unique set of hurdles. However, with adequate assessment and appropriate drafting in facility agreements and security documentation, it is possible to identify and mitigate these risks in a way which is both commercially acceptable to borrowers and provides adequate protection for lenders.

Jayne Backett is a London-based partner in the banking and asset finance group at law firm Fieldfisher, specialising in real estate finance and property fund finance.