With a wall of maturities ready to hit the data center industry in 2025 and beyond, banks and their clients are looking over options now as to what debt instruments will best serve their refinancing needs. The decisions they make will have huge implications for debt investors; reporter Matt O’Brien investigates.

Data center developers in need of refinancing will ratchet up the issuance of asset-backed securities as construction and acquisition loans from the pandemic era come due over the next two to three years, industry and bank executives told Infralogic.

Total outstanding data center asset-backed security (ABS) issuance will reach an estimated USD 50bn by 2027, double that of 2024, according to a study published by money management firm DoubleLine Capital in October 2024. Refinancings in 2025 will need USD 10bn to USD 20bn, with the US accounting for a majority, executives told this news service. Up to 75% of this may come through ABS transactions, according to one forecast. The data center industry currently accounts for approximately 5% of total ABS issuance.

“We expect the ABS market will be the dominant take-out option for data centers as it provides more structural flexibility to add new assets to the collateral pool, and raise capital through the existing master trust structure,” Valtin Gallani, group head of digital infrastructure finance and advisory for Société Générale (SocGen), told Infralogic.

The global data center market swelled to nearly USD 200bn in valuation in 2020, with some of that financed with construction loans at loan-to-value ratios of roughly 60%-75% or even 90% in some instances depending on type of facility and market, some executives said.

Infrastructure funds are big buyers of higher-quality ABS tranches – portions of a bond that are backed by the leases of typical infrastructure assets, such as data centers – as well as insurance companies that are probably the most notable investors of ABS notes, usually buying the most highly rated tranches.

ABS investors prefer multitenant facility deals as a hedge against lease renewal risk, yet rating agencies and investors are adapting to single-tenant hyperscale facility underwriting, ensuring issuance will grow, a source at an industry lender said.

Within the past year, ratings agencies issued new digital infrastructure lending criteria for ABS that provide more flexibility, said Alexander Tingle, managing director and head of data center banking for Goldman Sachs.

Even if a Microsoft, Oracle or Facebook decline a lease renewal with one of these facilities in a core market, there would be a line of several other tech firms waiting to take its place given the mission-critical status of such data centers, Tingle said.

“Quite frankly, the market loves single tenant. If you are an investment grade single tenant facility with a long-term lease, it mitigates the risk of an issue,” said Adam Lewis, a managing director for Citizens Capital Markets and Advisory.

Usually, single-tenant facilities have a lot more concentration of network gear and fiber, Lewis said. “Even if you’re doing a tech refresh, moving the network out of the data center is like saying that you can move beachfront real estate –  it’s where the network is.”

Greater supply, higher yields

Real estate firm Newmark published a report last year showing project finance teams offered terms at roughly 250 basis point spreads while Commercial Real Estate (CRE) banks and private credit firms submitted underwriting on spreads between 300 and 450bps.

This year, spreads tightened anywhere from 150bps to 200bps because certain investors became more familiar with the industry, reflected in the cost of equity remaining largely flat despite interest rates going higher, said Raimund Riedl, a director for Citi’s TMT and data center investment banking team.

As more refinancing supply comes online next year, possibly as much as USD 20bn, yields could bump higher even with new investors entering the market.

Despite short-term rates falling, it remains to be seen how the supply-demand dynamic of refinancings will affect debt pricing, Riedl said, keeping in mind that issuance issues going roughly from USD 5bn to as much as USD 20bn is “quite a big jump.”

“There are so many [asset managers with large balance sheets] where data centers currently are not in their mandate, but they’re going to shift that mandate … a percent or two gradually – it’s a big impact,” he said, adding that it could take anywhere from two to three years to watch this shift occur, slowly moving the supply-demand curves along the way.

SocGen expects to see several single tenant data center financings achieve investment grade ratings in the next nine to 12 months thanks to the recent changes in rating agencies criteria, Gallani said. That could impact pricing even further.

Data center investor Cloud Capital’s USD 1.3bn ABS, backed by four stabilized data centers, achieved “the highest rating of any data center ABS issuance under S&P Global Ratings new data center ratings methodology,” the firm said on 5 December 2024.

With market participants speculating on how much the Federal Reserve System lowers benchmark rates and talk of bond vigilantes returning, the rate environment could become volatile, impacting CFO decisions on which debt instrument to use for their refinancing needs.

“We expect that 60-70% of the stabilized data center refinancings will be done in the ABS market, with the rest split between Commercial Mortgage-Backed Securities (CMBS), US PP Private Placement (USPP) and institutional Term Loan B take-outs,” Gallani said. “However, the ABS market is rather sensitive to interest rate fluctuations. If rates are volatile, then the dynamics may shift towards more CMBS solutions.”

In some situations, the CMBS structure may result in higher debt proceeds through mortgages, which may be more attractive for certain issuers, he said.

In August, DigitalBridge Group- and IFM Investors-backed data center firm Switch tapped a USD 4.2bn credit facility – an upsized revolver and term loan – in a bank club deal that included 25 lenders so that it could build out new facilities and refinance its acquisition debt from when its sponsor took it private in 2022 and build out new facilities.

USPP, private credit’s moment

Fixed-rate private placements have been a rare commodity in the data center financing market, with issuers reluctant to take on financing with significant non-call provisions or prepayment penalties and lengthy tenors.

“US private placements would be more prevalent, but we have not seen many deals get done mainly since USPP investors need longer duration, while issuers are often reluctant to lock themselves into long-term financings with scheduled principal amortization,” Gallani said. “Currently most issuers prefer to stay within the five- to seven-year maturity range, while USPP investors and some CMBS lenders prefer seven years or longer.”

While many private placement maturities usually come in the 10-year range, 2024’s lone data center PP deal was a USD 700m financing agreement that saw investors accept a five-year tenor with data center company QTS Realty Trust. MUFG and TD served as lead arrangers for the Blackstone-backed company, said other sources familiar with the matter. SMBC was involved as the sole structuring agent for the QTS private placement deal.

None of the parties involved responded to requests for comment.

Will the QTS deal usher in additional PP dealmaking this year? Some executives consulted by Infralogic for this piece say so because CFOs will look to diversify their funding sources while onboarding as much financing as reasonably possible. With their track record in project finance and building internal credit teams over the years, infrastructure funds are comfortable buying into the relatively long-dated tenors of private placements, which offer an illiquidity premium and long-term, stable cash flows.

For issuers, private placements can sometimes be cheaper than an ABS. The financing method fits best when taking out construction loans on single-tenant hyperscale facilities, executives said.  

Structuring private placements can be “less cumbersome” as well, said Tingle’s colleague, Jason Tofsky, a partner and global head of digital infrastructure banking at Goldman.

Data center executives and lenders are turning to creative solutions incorporating private placements with ABS to take advantage of the former’s pros.

“The conversations we’re having regarding private placements of ABS structures are concerning finding new pockets of capital – private credit, sovereign wealth fund, pension fund, etc. – willing to commit significant capital, in some cases hold an entire transaction, which provides the issuer certainty of funds and in most cases an expedited process without formal ratings,” Citizen Capital’s Lewis said. “[The investor] relies on their own due diligence and turns out to be a quicker and less administratively burdensome approach to doing what otherwise would be a regular ABS or CMBS.”

The lender source said private placements are being underwritten on a project finance due diligence basis.

Private credit will also figure prominently into the refinancing conversation over the next couple of years and specifically could deal in the middle portions of a data center’s capital structure.

A lot of data center projects’ capital structures find themselves, for example, in the 65%-70% loan-to-value LTV range, only followed up with common equity. Given equity is more expensive, private credit could step in and offer cheaper mezzanine or preferred equity to sit in between the debt and the common equity, Tingle said and Tofsky said.

Gone are the days when sponsors could back projects with as little as 5% equity given the interest rate environment and covenants that lenders are demanding that have a particular focus on debt-service-coverage-ratios, Lewis said.

After all, private credit financing for hyperscale facilities whose offtaker is a Microsoft or Google could represent a roughly 200bps premium vis-à-vis investment-grade bonds those companies issue, said Tofsky.

“There have been processes we’ve run where we’ve gone out and solicited indications for the common equity or for the debt, but then we have guys that come back and say ‘we’re OK to do that but also have you thought about a term sheet for something that’s a little bit more mezzanine and getting the equity holders on board to put this into the capital structure,’” Tingle said. “So, I think that’s a theme you’re going to see from the private credit players.”

[Editor’s Note: The article has been updated post-publication to note that SMBC acted as sole structuring agent for the QTS private placement deal.]