The share of a data centre deal that is credit, and the share that is a bet on the building's second life.
Discount the cash flow the signed lease guarantees, rent plus energy margin less operating costs and reserves, over the years left on it, and divide by the price. An illustrative $900 million data centre with eight years left on a 32 MW hyperscale lease at $138 per kW per month produces $308.22 million of present value at 7.5 per cent: the lease covers 34.2 per cent of the price. The other 65.8 per cent is a bet on what happens when it ends.
Worked in full in The Digital Infrastructure Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A data centre leased to a hyperscale cloud tenant looks like a bond: investment-grade counterparty, fixed escalators, a triple-net structure. Buyers pay for it at a cap rate on year-1 income, which treats the rent as if it ran for ever. It does not. Leases run for a term, the halls are designed for a rack density that the next generation of chips may exceed, and at expiry the tenant can renew, renegotiate, or leave a building that needs a costly retrofit. The share of the price covered by the contract is the cleanest way to see how much of a data centre deal is credit and how much is a view on the asset's second life.
| Input | Value |
|---|---|
| Purchase price | 900 |
| Leased IT capacity | 32 MW |
| Capacity rent, rising 2.0% a year | $138/kW/month |
| Years left on the lease | 8 |
| Landlord operations, year 1, indexed 3.0% a year | 4.1 |
| Management, share of rent | 1.0% |
| Major-repair reserve, year 1, indexed 3.0% a year | 1.3 |
| Energy margin under the power clause | from the lease model |
| Discount rate | 7.5% |
The energy margin is the spread between the energy the tenant pays for under a PUE-capped pass-through and the cost of the energy the building actually uses; it is computed year by year from the lease terms.
Year-1 rent: 32 MW × 1,000 × $138 × 12 = 52.99.
Year-1 lease cash flow: rent 52.99 + energy margin 2.42 − operations 4.10 − management 0.53 − reserve 1.30 = 49.48.
Present value: Σ cash flowt / 1.075t for t = 1 to 8 = 308.22.
Coverage: 308.22 / 900 = 34.2%. Uncovered: 900 − 308.22 = 591.78.
In Excel: =NPV(7.5%,C20:J20)/Price on the row of lease cash flows.
| Year | Rent | Energy margin | Costs and reserve | Cash flow | Discount factor | Present value |
|---|---|---|---|---|---|---|
| 1 | 52.99 | 2.42 | -5.93 | 49.48 | 0.9302 | 46.03 |
| 2 | 54.05 | 2.85 | -6.10 | 50.80 | 0.8653 | 43.96 |
| 3 | 55.13 | 3.29 | -6.28 | 52.15 | 0.8050 | 41.98 |
| 4 | 56.24 | 3.74 | -6.46 | 53.51 | 0.7488 | 40.07 |
| 5 | 57.36 | 2.32 | -6.65 | 53.03 | 0.6966 | 36.94 |
| 6 | 58.51 | 2.26 | -6.85 | 53.92 | 0.6480 | 34.94 |
| 7 | 59.68 | 2.20 | -7.04 | 54.83 | 0.6028 | 33.05 |
| 8 | 60.87 | 2.13 | -7.25 | 55.75 | 0.5607 | 31.26 |
| Total | 423.47 | 308.22 |
The energy margin dips in year 5 because the landlord's fixed-price power contract ends and the assumed market price is higher.
The 591.78 not covered by the lease must be paid for by everything the contract does not guarantee: any expansion capacity, and the building's value after year 8, whether the tenant renews at a reset rent, the halls are retrofitted for denser racks, or the space is re-let to several smaller tenants. To see the size of that bet, ask what the asset would have to be worth at the end of year 8 for the purchase to earn 7.5 per cent if the lease were its only income until then: 591.78 × 1.0758 = 1,055.43, or 32.98 per leased MW, against 28.12 per leased MW paid today. That is 18.9 times the last lease year's cash flow of 55.75, for a building eight years older, with eight years less of a contract and in a market where rack densities will have moved on.
| Years left on the lease | At 6.5% | At 7.5% | At 8.5% |
|---|---|---|---|
| 3 | 14.9% | 14.7% | 14.4% |
| 5 | 23.9% | 23.2% | 22.6% |
| 8 | 35.6% | 34.2% | 32.9% |
| 12 | 49.0% | 46.4% | 43.9% |
| 15 | 57.5% | 53.8% | 50.5% |
The term moves the answer far more than the discount rate. A hypothetical fifteen-year term at the same rent would still leave close to half the price uncovered; even a long hyperscale lease rarely pays back the asset. Three years before expiry, an investor buying at the same price would be paying 85 per cent or more for the residual.
Undiscounted, the lease pays 423.47 of cash, 47.1 per cent of the price, and gross rent alone sums to 454.83, or 50.5 per cent. Neither is a coverage ratio; both are sometimes quoted as one.
Pricing the building on a cap rate and calling it bond-like. The year-1 lease cash flow of 49.48 is a 5.50 per cent yield on 900, which looks like a credit spread over government bonds. But a bond returns its principal at maturity and this lease does not: only 34.2 per cent of the price is backed by the contract, and the rest depends on a negotiation in year 8 that the buyer cannot control. Model the outcomes at lease end explicitly, with their capex and their probabilities, rather than letting an exit cap rate on year-11 income assume renewal.
Discount the contracted cash flow over the remaining term and divide by the price: here 308.22 of 900, or 34.2 per cent. The rest needs the building to be worth about 1,055.43 when the lease ends just to earn the discount rate. The lease, the power clause, the four outcomes at lease end and three valuation methods are in the free workbook for this case. For how the power clause inside this cash flow works, see how a data centre makes money on power pass-through.
Separate the contracted cash flow from the residual. Discount rent plus energy margin less costs over the remaining term, then value the outcomes at expiry explicitly. In the worked case eight years of lease are worth 308.22 at 7.5 per cent, so 591.78 of a 900 price rests on the residual.
Only partly. The counterparty may be investment grade, but the lease does not return the principal. In the worked case the lease covers 34.2 per cent of the price; to earn 7.5 per cent with the lease as its only income until expiry, the asset must then be worth 1,055.43, 18.9 times its last lease-year cash flow.
Much more than the discount rate. At 7.5 per cent the illustrative lease covers 14.7 per cent of the price with three years left, 34.2 per cent with eight and 53.8 per cent with fifteen; moving the rate from 6.5 to 8.5 per cent changes the eight-year figure only from 35.6 to 32.9 per cent.
This article is one calculation from The Digital Infrastructure Investor. 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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