One point of escalator priced as starting rent, for the owner who holds to expiry and for the developer who sells at year seven.
Over a fifteen-year lease, a data centre rent of $105 per kW-month escalating at 3 per cent pays the same total as $112.93 escalating at 2 per cent. One point of escalator is worth 7.5 per cent of face rent. Discount the rent at 8 per cent and the equivalent falls to $111.37; for a developer who sells after seven years it is $111.02 (hold NOI plus exit value, undiscounted), because the buyer, not the developer, collects most of the escalator.
Worked in full in The Data Center Development Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The case is the book's turnkey campus: 180 MW leased at $105 per kW-month net of power, producing $215 million of year-one net operating income. The book debates a 2 per cent against a 3 per cent escalator and states neither. The discount rate, the seven-year hold and the 7.75 per cent exit cap are the inputs a developer would use to test the trade; the discount rate is illustrative.
| Input | Value |
|---|---|
| Contracted capacity, MW | 180 |
| Starting rent with a 3% escalator, $ per kW-month | 105 |
| Year-one NOI, $ million | 215 |
| Lease term, years | 15 |
| Discount rate, illustrative | 8% |
| Developer's hold, years | 7 |
| Exit capitalisation rate | 7.75% |
An escalating lease pays the starting rent times the sum of the growth factors over the term. Two leases are equivalent when those totals match, so the starting rent that compensates for a lower escalator is the ratio of the two sums.
Sum of growth factors = Σ (1 + g)t, t = 0 to 14
At 3 per cent: 18.60. At 2 per cent: 17.29.
Equivalent starting rent at 2% = 105 × 18.60 / 17.29 = $112.93, an uplift of $7.93 or 7.5 per cent
In Excel: =105*((1.03^15-1)/0.03)/((1.02^15-1)/0.02). For the discounted version, put each year's rent divided by 1.08 to the power of the year in a helper column and compare the two column totals.
On the full campus the gap is large in dollars. Fifteen years of NOI at 3 per cent total $3,998.8 million; at 2 per cent from the same starting rent, $3,718.1 million. The point of escalator is worth $280.7 million of NOI over the lease, and the tenant who asks for 2 per cent should be asked for $7.93 more a kilowatt-month in return.
The undiscounted equivalence treats a dollar in year fifteen like a dollar in year one. Discounting at 8 per cent shrinks the back-ended advantage of the higher escalator, and the equivalent starting rent falls to $111.37, an uplift of 6.1 per cent. The longer the wait, the less the escalator is worth.
The holder matters more than the discount rate. The two rent paths cross between year 8 and year 9: the 2 per cent lease pays more up to year 8, the 3 per cent lease from year 9 onwards.
| Lease year | $105 at 3% | $112.93 at 2% |
|---|---|---|
| 1 | 105.00 | 112.93 |
| 7 | 125.38 | 127.17 |
| 8 | 129.14 | 129.72 |
| 9 | 133.01 | 132.31 |
| 15 | 158.82 | 149.00 |
A developer who sells after seven years collects the early years and then sells the year-eight rent at the exit cap. On the campus, the $112.93 lease earns $1,719.0 million of NOI over the hold against $1,647.4 million, $71.6 million more, and its year-eight rent capitalised at 7.75 per cent gives an exit value of $3,427.2 million against $3,411.9 million. In total the developer is $86.9 million better off with the lower escalator at the “equivalent” rent. On undiscounted hold NOI plus exit value, the rent that leaves a seven-year holder indifferent is only $111.02, an uplift of 5.7 per cent.
The 3 per cent case reproduces the book's own exit: $3,411.9 million is the gross sale in the companion workbook's base case. The escalator debate is not academic. In that workbook the levered return is 18.6 per cent on a flat lease and 22.6 per cent with a 3 per cent escalator.
| Lease term, years | Undiscounted, $ | Uplift | Discounted at 8%, $ | Uplift |
|---|---|---|---|---|
| 10 | 109.93 | 4.7% | 109.25 | 4.1% |
| 15 | 112.93 | 7.5% | 111.37 | 6.1% |
| 20 | 116.12 | 10.6% | 113.29 | 7.9% |
The value of a point of escalator rises with the term: 4.7 per cent of face rent over ten years, 10.6 per cent over twenty. Discounting compresses the range, because the extra rent sits in the years discounting penalises most.
The usual error is to compare the escalators on year-one rent alone and accept the tenant's higher starting figure as a win, or the reverse: to treat the 7.5 per cent term-equivalent as the price for every party. The undiscounted figure is right for a holder to expiry who is indifferent to timing. A developer selling at stabilisation should use the hold-period figure, and should check the exit assumption behind it. The lower-escalator lease is worth $15.3 million more at exit only if the buyer applies the same 7.75 per cent cap. A buyer who widens the cap by 3.5 basis points, to 7.78 per cent, for a lease that grows more slowly removes that advantage entirely, and most buyers will widen it by more.
Price the escalator as a starting-rent equivalent before negotiating either term. On a fifteen-year lease one point is worth $7.93 a kilowatt-month to a long-term owner, $6.37 discounted, and about $6 to a seven-year developer, provided the exit cap holds. The full escalator schedule, the flat-rent case and the levered returns are in the free workbook for this case; the effect of a rent shortfall on the same campus is in the delay against the rent miss.
Only at the right starting rent. Over fifteen years, $105 at 3 per cent and $112.93 at 2 per cent pay the same total. Below $112.93 the 3 per cent lease wins for a holder to expiry; above it the 2 per cent lease does. On a 180 MW campus the point of escalator is worth $280.7 million of NOI over the term.
Longer leases make the escalator worth more because the compounding has longer to run. Matching $105 at 3 per cent with a 2 per cent lease needs a starting rent 4.7 per cent higher over ten years, 7.5 per cent over fifteen and 10.6 per cent over twenty, undiscounted. Discounted at 8 per cent the uplifts are 4.1, 6.1 and 7.9 per cent.
The higher escalator pays its advantage late, after a seven-year seller has gone. The lower-escalator lease at the equivalent rent pays $71.6 million more NOI during the hold on a 180 MW campus, and its exit value is similar. On undiscounted hold NOI plus exit value, a seller is indifferent at $111.02, not $112.93, provided the buyer keeps the same 7.75 per cent exit cap.
The escalator debate is set out in Chapter 13 of The Data Center Development Handbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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