INTERVIEW: Merlin’s pioneering move into data centres

Co-founder David Brush explains why the Spanish REIT is entering the sector with a commitment to invest €500 mln over the next few years

PropertyEU: Merlin Properties is the first European property company to step into the data centre market on the development front. Can you comment on the rationale for entering the sector?

Brush: There are several reasons why we think this decision makes sense. If you look at the last five years the number of submarine cables linking Europe with the US and the Americas has increased exponentially, particularly with landing points in Spain and Portugal. Connectivity through fiber optic trunk lines is also rising quickly. So the foundation is there for business.
If you look at the need for cloud data and streaming services, it existed pre-Covid but it has exploded with the pandemic. When you add in 5G networks, which are being developed, that creates an even broader need for data. This is a long term trend and we are getting in at the very initial part of the game.
Another major factor is that data centres are very compatible with logistics, so this means that like industrial buildings, data centres need large plots of land in well connected locations near major fiber optic trunk lines. We already own well-connected plots and we will use our existing land bank for the development.
Also, we are looking at superior returns with respect to logistics which is our best asset in this sense. Data centre provide mid double digit returns on a levered basis. We can earn even better by making EV charging stations available on the site, as we expect a significant ramp-up in electric vehicles charging and we can share the battery infrastructure, increasing our return on cost.  
Data centres are a complicated business and you cannot step in without knowing the ropes. We have been able to find a partner (Endeavour) with extensive experience in the sector as they have built over €5 bn of data centre projects in the past. Their technology is superior to their peers as they have discovered a way to make waterless, more-efficient data centres. Generally, data centres generate a dramatic amount of heat and as such require cooling pools, but Endeavour’s unique system is able to extract the heat from the facility which is significantly cheaper and makes no use of water. Their data centres also have the highest energy density, which means you can put more racks in your facility. So we have the ability to produce more revenue from the same space.

PropertyEU: How is the partnership with Endeavour structured?
Brush: We have agreed on an incentive-based management contract. Under the arrangement, we, Merlin are the owners and we will fund 100% of construction costs while also being responsible for managing the real estate side of things. Our partner is responsible for design and for the technology on site. We will jointly handle leasing.
The contract effectively means that they don’t earn anything unless we make the returns we set out in the arrangement. This just shows how confident they are in achieving those returns. It is fair to say that this industry is maturing, we are projecting returns which have been generated before in this space without the benefits of Endeavour’s technology. Also, the returns for data centers in Europe are expected to be higher because it is a less mature market than the US, with far less competition. The number of data centre specialists in Europe can be counted on one hand (take Digital Realty, Equinix, Global Switch and DATA4) while the logistics space has become extremely crowded in the recent past.

PropertyEU: How do you expect the sector to develop in the near future?
Brush: If we look at the US, which is ahead of Europe, tower and data centres represented less than 5% of the NAREIT index back in 2012, but they now represent 30% of the index.  This just shows how rapid this industry is growing.
Also, institutional capital is starting to enter the sector. We have recently seen Ascendas REIT, a Singaporean REIT sponsored by CapitaLand, make its first foray in the European data centre market with the acquisition of a portfolio of existing data centres. This is an institutional kind of play and we will see more of this.
Right now, data centres are a niche, alternative asset class, same as logistics was a decade ago, but as we go forward, with the tailwind of demand it is seeing and the returns it is able to offer, it will draw more and more institutional capital.

PropertyEU: Can you detail Merlin’s development plans?
Brush: We have identified four projects in a first phase, for a total of 70 MWs. The first sites in Barcelona and Madrid will support up to a total of 20MW of load each. Bilbao and Lisbon will follow suit, with the infrastructure to support hyperscale builds in excess of 100MW each (20MW in Phase I). In total we expect to make an investment of close to €500 mln, estimating the development cost at about €7.5 mln per MW.
In the case of Madrid and Barcelona, we are currently developing the specifics to present projects for approval by the town hall. The biggest unknown is the timing of planning permission but given that the sites are already marked for logistics development, we hope to have product available for lease within 18 months.


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