By: Jon Falker, Director of Marketing, Prime Data Centers
Photo by Cytonn Photography on Unsplash
Data center decision-making teams are often cross-functional, as they should be. They consist of financial and facilities professionals that typically work within the Chief Financial Officer’s organization, as well as IT professionals that typically work within the Chief Information Officer’s or Chief Technology Officer’s organization.
This post will help level-set everyone on the major categories of data center leases and the implications that the lease structure has on the technical side of the decision-making team.
In data center leasing, there are three common leasing models: triple net (“NNN”), modified gross, and gross (otherwise known as “full-service” or “all-in”). The first two generally fall under the wholesale category, while gross/full-service/all-in is typically for retail colocation or unusually small wholesale deals of 1MW or less.
We’ve seen some blurring of the lines between clients looking for wholesale versus retail. Sometimes the decision-making team is focusing their search on retail colocation providers when the particulars of their needs are actually better suited for a wholesale deal.
There are advantages and disadvantages to each for both the data center customer (i.e.: “tenant”) and the data center real estate developer. We’ll show you which is likely best for each common scenario.
For a deeper dive, retail colocation directory UpStack wrote a great post covering the details of exactly what gets included in each kind of lease.
To understand the lease structures below, we need to define Critical Load and Essential Load. Critical Load is the direct electric power consumption of the customer’s equipment. The Essential Load is the additional electric power consumption required by the cooling of that equipment.
There are more definitions in the small glossary below:
- NNN: Triple Net Lease. A real estate lease that passes through all of the customer’s share of the operating expenses, both shared and unshared.
- Modified Gross: Modified Gross Lease. A real estate lease that includes at least some pro-rata share of the OPEX in the base rent.
- Gross/Full-Service/All-In: All-In Lease. A real estate lease that includes all of the client’s share of the OPEX in the base rent, so that the client only pays one predictable rent line item.
- MEP: Mechanical/Electrical/Plumbing. Part of Data Center Control Systems (DCCS), which are sometimes part of a larger Building Management System (BMS). Ongoing MEP costs can be part of the larger OPEX.
- CAM: Common Area Maintenance. Any OPEX or CAPEX incurred by the landlord in the upkeep and maintenance of areas and assets shared by multiple customers.
- CAPEX: Capital Expenditure. An investment that will provide a future benefit. Usually a one-time cost versus a recurring cost. Examples include development, acquisition or upgrades of real estate.
- OPEX: Operating Expenses. Any expenses related to the ongoing operation of a given real estate asset. Often recurring costs versus one-time costs. Examples can include MEP and CAM.
- TCO: Total Cost of Ownership. The total cost of owning an asset, including both acquisition cost (CAPEX) and OPEX over the life of the asset, as well as any sale costs.
- Build-to-suit: A real estate project that is built to the unique specifications of a specific client.
- Multi-tenant: When multiple data center customers are housed in the same facility. Always applies to retail colocation and can even apply to wholesale arrangements.
Triple Net or NNN
What is it?
NNN consists of a base price (often quoted in $/kW), plus your proportional share of mutual operating expenses for the building, plus your monthly Critical Load consumption, plus your Essential Load cost. These “recoverable costs” are often around $35/kW and include items like property tax, maintenance, human resources, etc.
Pros:
- Increases operating cost transparency for the customer
- Customer can benefit from lower than expected operating expenses
- Customer can collaborate with landlord to make systematic efficiency improvements
- Lower TCO long-term (no indexation on operating costs and management fees vs. MG, which does index those)
Cons:
- Increases accounting and cash flow complexity for customer, higher admin burden
- Customer assumes the risk of higher than expected operating expenses
- More variability in costs over the term of the lease
Best Suited For:
- Large wholesale lease customers, like hyperscalers, or retail colo providers
- Large enterprise customers looking to exit facilities management but retain control over their data center equipment and operations
- Sale/leaseback
- Longer lease periods
- Customer/developer joint ventures
- Newer facilities
Modified Gross
What is it?
The base rent includes the pro-rata share of common operating expenses, also known as common area maintenance (“CAM”). A base year is often included as an index so that the landlord can calculate increases in operating expenses which can be passed through to the customer. This is referred to as indexation.
Pros:
- Some operating expense variability risk transferred from customer to developer
- Greater rent expense predictability versus NNN
- Predictable, fixed payment each month, indexed yearly…simple
- No unpredictable OPEX increases
Cons:
- Customer is paying for some owner/developer margin tacked onto the operating expenses charge, but not as much as they would for a Gross Lease
- Potentially higher TCO over the long term
- Less transparency on OPEX
Best Suited For:
- Turn-key
- Build-to-suit
- Older facilities
- Wholesale customers that don’t have Fortune 500 or hyperscale-sized data center portfolios with the accompanying internal teams to manage and optimize those asset portfolios
Gross, Full-Service, or All-In
What is it?
The all-inclusive version. All-In leases (or Master Services Agreements as is often the case for retail colo) present one all-in price to the customer. Similar to Modified Gross, but power is included.
Pros:
- Least amount of accounting and cash flow complexity for customer
- Higher expense predictability
- No cost of power risk
- Power consumption at risk of landlord
Cons:
- Least amount of transparency on operating costs for customer
- Customer can’t take advantage of their own operating efficiency
- Highest total cost of operation when evaluated on a per-unit basis
- Paying for possible over-subscription of power, limited per circuit
Best Suited For:
- Smaller, multi-tenant deals like retail colo
- Shorter lease periods, <5 years
Conclusion
Wholesale data center developers typically engage in NNN or Modified Gross leases. The major change occurring in the market is the reconsideration of the threshold for retail colo versus wholesale. While that threshold is often assumed to be the 1MW mark, we see a lot of companies with needs from 300kW – 1MW that could stand to benefit greatly from moving up to a wholesale deal.
You may want to additionally consider taking an equity position in your new wholesale deal. That can open up meaningful advantages related to accounting and taxes. One excellent way to take an equity position is through a joint venture with your wholesale data center developer.
Another thing to pay close attention to as you right-size your data center resources is your power utilization. Some retail colo providers provide power only in “blocks” of 300 or 500kW, which may be larger than your actual consumption. By contrast, some wholesale data center developers will meter your specific power usage and pass that through directly to you. That way, you pay only for what you actually use, not what you “might” use.
We’re seeing many companies that started with retail colocation, then saw their businesses and staff grow and don’t even realize that they are double paying (keeping their own data center staff and paying for full-service colocation services). If your company’s data center needs are around 1MW, and you’re in a retail colo situation, you may be overpaying. It makes sense to double-check to see if it might be time to graduate to a wholesale deal, even if your total needs are only in the 300kW – 1MW range.
To conduct this review successfully, make sure you appoint a cross-functional team with representation from both the facilities/finance department and the IT department. The data center market is no longer just a “real estate play.” The IT staff is now heavily engaged in these decisions because the location of the data has a major impact on performance and safety.
Bio
- Follow Prime Data Centers on Twitter @primedatacentrs
- About Jon Falker: Jon Falker is the Director of Marketing for Prime Data Centers. He has over a decade of marketing leadership, from SaaS startups to Fortune 100 tech bellwethers like Intel. Jon has experience leading all aspects of marketing, including branding, messaging, strategic positioning, profitable revenue growth, and customer feedback.
