The advent of generative AI and machine learning has increased the global appetite for data in our increasingly digitised world. All this information needs to be stored somewhere, and property investors and developers are keen to gain exposure to this rapidly evolving sector. While the underlying asset is undeniably the real estate, the legal disciplines involved in a successful project spread far further. Here are some aspects to consider when making a play in this market.
Power procurement
Availability of power is a critical concern in assessing the viability of any project. Data centre facilities need uninterrupted supply to enable the servers to function.
A particular issue affecting UK data centre developers is challenges in obtaining a suitable grid connection. Limitations on available electricity network capacity and increasing demand are leading to long lead times for new connections, with energisation dates 10 years or more in the future not uncommon. Reforms are in motion to increase investment in electricity networks, accelerate the development timeline for electricity transmission infrastructure and streamline the connections process – but these will take time to develop and implement.
In addition, data centres are huge power users. There has been a focus on sustainability in recent years, with users looking at methods of ensuring that the power used to operate the sites is green. This has led to the increasing popularity of corporate power purchase agreements that are being used by data centre operators who enter into long-term agreements for the purchase of power and/or renewable energy guarantees of origin. In doing so, users need to take care in ensuring that renewable energy claims are not misleading.
Planning
Local authorities do not adopt a consistent approach to the treatment of data centres. While some as a matter of course consider them to be either a class E business use or a B8 storage/distribution use, others deem they do not fit into a standard class and are of their own kind (sui generis). This individual view means it can be difficult to predict the likely outcome of an application, although early pre-application discussions with the council are a benefit.
Often, the use class will be a more technical matter and will depend on the way the data is stored and for what purpose. In recent cases, planning officers have also considered whether subsequent conventional commercial, storage or distribution uses could operate from the building when ascertaining the relevant use classification.
Data centres are not mentioned in the National Planning Policy Framework, which further leaves the different local authorities to their own devices and local plan policies (to the extent that they have any which apply to data centres). If the local authority considers that a data centre development would conflict with local policy, political objectives, or the needs of a certain constituency (particularly as regards housing, power or water supply) the application could be rejected as local authorities seek to make room for alternative development, for example, affordable housing.
Construction
Scarcity of materials, skilled labour and contractors who genuinely understand and specialise in data centre developments mean that the sector can be particularly vulnerable to suffering delivery delay. Depending on the contractual model used, there will be different considerations when allocating risk. Being able to open a facility on time, free of defects and snags and with minimal risk of downtime is critical for end users. Key performance indicators are common, with strong liquidated damages provisions for any failure to deliver to the agreed performance standards.
Minimising risk
As large consumers of electricity and producers of greenhouse gases, data centre operators are under scrutiny to demonstrate their green credentials. Whether through corporate power purchase agreements or other arrangements, operators and developers will be keen to be able to trace the provenance of their supplies and any environmental benefits they can provide, such as finding an alternative use for the waste heat produced. Efficiencies of operation can also make inroads into reducing consumption and emissions.
Given the amount of heat generated by servers in a data centre, one of the greatest health and safety risks is fire. Such risks can be mitigated by fire prevention and suppression systems and automated safety systems to reduce the requirement for human involvement and streamline processes.
National security considerations
This is quite a fast-moving and evolving area. The government has just launched a consultation on “protecting and enhancing the security and resilience of UK data infrastructure” with an aim of sourcing views on the proposed measures required to improve the security and resilience of data infrastructure. The goal is to “ensure all relevant operators in the UK are appropriately mitigating risks where they are relevant to the national interest, and national security in particular”. The consultation closes in February 2024, and we expect to see further regulation measures implemented as a result.
Furthermore, “data infrastructure” is one of the 17 sectors which could mean a transaction requires a mandatory notification under the National Security and Investment Act 2021. Even where a mandatory notification is not required, the government has wide-ranging powers to call in transactions (including asset acquisitions) for review where it has national security concerns. The government’s annual report on the operation of the 2021 Act, published in July 2023 and covering the period 1 April 2022 to 31 March 2023, indicates that data infrastructure saw the third highest number of mandatory notifications filed, and also represented just under 5% of all voluntary notifications submitted.
The data infrastructure sector also represented just under 10% of the 65 call ins, where the government called a transaction in for a more in-depth review, indicating that these transactions are of potential interest to it. That said, no data infrastructure transactions were subject to remedies in the period, suggesting that, while the government is scrutinising the sector, so far such transactions have not raised significant concerns.
In November 2023, the government launched a call for evidence to inform potential reform of the 2001 Act, which included questions related to the definition of specified activities in the data infrastructure sector, meaning that we could see some clarification or reform of which data centre transactions would require mandatory notification. The timing of any reform remains unclear.
Customer contracts
Various models are used in the sale of data centre services to end users. At different levels there could be leases, licences or operating agreements – with each type of agreement having its own individual peculiarities.
The key issues, which a customer should ensure are covered in any agreement where services are being provided, will be continuity and quality of service (through measures such as uptime guarantees, technical support response times and incident response times, with corresponding service levels and service credits payable for failures to deliver against the agreed service levels), security (both in terms of physical and cybersecurity), data privacy and compliance measures (including allocation of responsibility for the processing of personal data and processes for reporting and responding to data breaches), scalability/flexibility (allowing the needs of the customer to vary according to need through the life of the relevant contract), disaster recovery and business continuity (allocation of responsibility in the event of a disaster for data back-up, recovery and continuity of operations) and exit (how data will be migrated away from the data centre provider back to the customer or replacement supplier on the expiry or termination of the contract, to ensure continuity in the transition period).
Caution urged
Data centres are producing excitement in the market. They are perceived as a more mainstream asset class and investors are keen to share in the potential gains. But care needs to be taken to ensure those new to the sector are aware of the pitfalls.
Top tips for exploring the sector
- Plan ahead Both power and consenting can take time to achieve. By considering these aspects early in the transaction disappointments can be avoided. By allocating time and resources you can present a strong proposition.
- Future-proof the investment By providing the ability for customers to start smaller but scale up you will avoid losing those who need to grow. Granting options or pre-emptions on future data halls can provide comfort here.
- Know your customer Understanding the needs of the end consumer is vital to making your project a success. Standard institutional documents are unlikely to be palatable to those looking to operate space for co-location. Keep abreast of the current trends to understand what will be attractive to your market.
Charlotte Miller is a senior associate at CMS Cameron McKenna Nabarro Olswang LLP
