Key Points
- Data center construction is in the midst of a generational super cycle, driven by the confluence of cloud computing’s continued growth and the explosive, nonlinear demands of AI.
- The infrastructure appetites of the world’s largest technology companies — the “hyperscalers” — have spawned innovative financing solutions that combine project, real estate and leveraged finance concepts to support developers, investors and lenders seeking to capitalize on the rapid expansion of the data center market.
- To achieve the most efficient financing structure over the life of a project, developers may want to develop a strategy early on based on how the capital needs and project risks will evolve so they can transition over time to lower-cost debt.
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Competition among hyperscalers for market dominance in cloud computing and artificial intelligence (AI) has created a capital-intensive race for developers to build out the next generation of data center infrastructure.
To match the pace of this demand, developers are deploying a range of innovative financing solutions. These solutions are tailored to the unique risk profiles of modern data center projects — often massive, single-tenant campuses for creditworthy hyperscalers that can require power capacity in excess of 1 gigawatt and billions of dollars in initial construction capital.
Understanding the core financing strategies is critical for developers, investors and corporate treasury teams navigating this competitive landscape.
Overview of Financing Strategies
Construction Financing
The foundation of any data center financing strategy is project-level construction debt. This project-specific debt finances the direct hard and soft costs of building a data center (or data center campus), covering a portion of project costs from the construction phase through the initial operational phase — typically for a term of three to five years.
Unlike traditional commercial real estate loans, which are primarily underwritten based on the value of the underlying real property, hyperscale data center construction financings are also underwritten on:
- Creditworthiness of the tenant(s).
- Quality of the anticipated cash flows from the lease.
- Risk profile of the lease (e.g., tenant termination rights and the cost/risk allocation between the tenant and landlord).
- Developer’s track record.
- Financeable construction arrangements with creditworthy counterparties.
This market has seen exponential growth over the last few years, and its participants — including developers, lenders, technical consultants and title companies — are becoming increasingly sophisticated.
With headline-grabbing megadeals becoming increasingly common, developers must address financing considerations early in the process to ensure access to sufficient debt financing on optimal terms. Lenders expect a coherent development narrative that is responsive to common diligence, tax, structuring and state/local concerns (including power).
As a condition precedent to financing, lenders typically expect copies of all material project documents (e.g., the lease and a construction contract with a guaranteed maximum price) and third-party reports (e.g., the appraisal, technical consultant report and Phase I environmental site assessment), similar to nonrecourse financings elsewhere in the infrastructure industry.
As competition for capital and resources continues to grow, the ability to move rapidly from land acquisition to initial funding is becoming a key strategic differentiator.
HoldCo Financing
For developers managing a portfolio of projects or project-level construction risk, holding company (HoldCo) financing can be a strategic complement to project-level construction debt. HoldCo debt is incurred by an up-the-chain parent borrower, outside of the project-level credit group.
In lieu of receiving a direct security interest in the project-level assets, a HoldCo facility is typically:
- Secured by a pledge of the parent company’s equity interests in the underlying data center project.
- Serviced through upstream distributions from the underlying hyperscaler data center asset.
Key lender protections can include:
- Cash flow sweeps.
- Control over accounts/cash management.
- Consent rights with respect to material project contract modifications.
- Limitations on distributions.
- Information and notice rights.
- Financial covenants tied to the performance of the underlying construction loan.
This structure provides developers with greater operational flexibility and can be especially effective for managing unforeseen delays and cost overruns at the project level.
In lieu of debt financing, HoldCo-level financings often are structured as mezzanine equity investments.
Refinancing and Takeouts
Once a data center is operational and generating predictable lease revenue, the risk profile of the asset fundamentally changes. At this stage, construction risk is eliminated and the initial construction debt is often replaced — or “taken out” — by permanent financing.
The transition to stabilized financing can:
- Unlock trapped equity.
- Create opportunities to sell or otherwise monetize data center assets.
- Provide a lower cost of capital.
- Include more flexible, investment-grade terms.
This long-term capital is priced based on the creditworthiness of the tenant and stable cash flows generated by the hyperscaler tenant’s lease.
Common forms of takeout financing include broadly syndicated term loans, private placements and asset-backed securitizations (ABS), all of which typically offer more favorable terms (including advance rates) and lower borrowing costs than construction loans. Planning for an eventual takeout financing (or other source of permanent capital) should be initiated as early as possible and can help ensure a cost-effective transition between the construction and operational phases of the project.
In Sum
The data center financing market is maturing rapidly. The lines between project, real estate and leveraged finance are blurring. Successful capital planning requires a coherent strategy that aligns capital sources with the distinct stages of an asset’s life cycle.
Proactive developers who engage their core finance, construction, tax and legal teams early on in the process will be best positioned to rapidly execute, mitigate syndication risk and optimize the cost of capital in an increasingly competitive market.
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.