Data centers have become one of commercial real estate's most popular investments.^1^
So why are some asset managers taking a cautious approach to one of the market's most talked-about assets?
It boils down to three investment risks that are worth examining more closely: concentration, exit liquidity, and technological obsolescence.
Let's unpack each one.
The Diversification Problem
A widely accepted rule of thumb in equity investing is that no more than 10 to 20 percent of a portfolio should be concentrated in a particular stock.^2^ Many real estate managers apply similar logic when evaluating portfolio concentration.
Data centers can make that surprisingly difficult.
Building a modern 100-megawatt data center costs approximately $1 billion. The largest hyperscale facilities can cost considerably more.^3^
That introduces a challenge for even very large real estate funds. If a $4 or $5 billion fund owns a single hyperscale data center, that one investment could account for 20 percent or more of the portfolio. By traditional diversification standards, that's a highly concentrated position.
That's a level of concentration, and, by extension, risk, that some asset managers may view as difficult to justify.
Who’s the Buyer?
Experienced real estate investors often understand the importance of an exit. If hundreds of millions of dollars are going into land acquisition and development, there needs to be a credible path to a sale.
When it comes to data centers, however, that path can be less straightforward than in other asset classes.
Unlike an apartment building or office tower, the universe of potential buyers for a billion-dollar data center is relatively small. In many cases, the most logical purchasers would be the very hyperscalers leasing the facilities: companies like Google or Amazon.
But that raises a reasonable question: if those companies ultimately wanted to own the asset, why didn't they acquire or develop it in the first place?
That uncertainty is enough to give some real estate managers pause.
Demand for data centers may be strong today, but real estate investing is ultimately about both the purchase and the exit. Without a clear path to liquidity, committing significant capital to a single development becomes a more complex proposition.
The Innovation Risk
What's the one thing nearly every piece of technology has in common: phones, cameras, computers?
Over time, it gets smaller.
Today's data centers require enormous physical footprints, with the largest hyperscale facilities often requiring 500 to 800 acres of land.^4^ But what happens if the next generation of servers can deliver the same amount of compute in half the space? What happens if they become dramatically more energy efficient and require less power infrastructure?
Those questions don't have clear answers, but they do highlight potential risks worth considering.
Future innovation cycles could leave large portions of existing data centers underutilized. And if that happens, there is no guarantee there will be replacement tenants ready to absorb the excess space.
For some real estate managers, that's a risk they're not willing to underwrite.
When Enthusiasm Outpaces Due Diligence
None of this is to suggest that data centers are a "bad" investment. Data centers offer real potential, including long-term lease structures and demand driven by AI and cloud computing. The point, simply, is that it is always worth pausing to ask a few questions.
What assumptions are being made? What risks could lie ahead? And how are professional investors, like asset managers and institutions, evaluating the opportunity?
Every investment carries risks that may not be immediately apparent, and data centers are no exception.
Sometimes, the most valuable investment insight comes not from asking what everyone is buying, but from asking what risks a manager is weighing before committing capital. Explore offerings from established private market managers on Crowd Street.
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