Data centers, cold storage and electronics manufacturing are three real estate-adjacent industries that have surged in emerging markets due to the pandemic. Data centers due to AI and digitalization, cold storage due to refrigeration of food and drugs, and electronics manufacturing due to higher demand for automation.
From an industrial developer’s perspective, the typologies of these buildings have common attributes that provide investment opportunities for decarbonization. These structures need efficient insulation against heat so electricity costs are highly correlated with developer returns. Operations require uninterrupted power 24/7 and the predictable portion of the load curves are related to external ambient heat.
Firms that lease these facilities generally manage their corporate image (ESG), conscious of their high energy consumption. The boom in these real estate sectors have given property developers the financial capacity to invest in new technologies for decarbonization, as long as it does not interrupt operations of their tenants.
Why do industrial real estate developers go green?
High energy usage is not only costly in terms of climate impact, but also prevents developers from maximizing operating income and valuations. Many investors and banks have made net-zero commitments, tenants demand more sustainable buildings, employees demand action and governments are passing laws targeting emissions.
Lower cost construction loans: From a project finance perspective, emerging market banks are beginning to provide lower interest rates to projects with green uses of proceeds. In 2016, Colombia’s largest bank raised $117m in a green bond issuance and now offers green construction loans at 50 to 200 basis points lower than non-green loans.[i]
Lower cost of capital: From a corporate finance perspective, debt capital markets globally have seen an explosion in Green bonds, Social bonds, Sustainability bonds, Sustainability-linked bonds, Green loans, and Sustainability-linked loans. Neuberger Berman estimates that green bond issuers are able to raise capital at an interest rate 5 basis points lower than regular bonds. [ii] In 2021, $95Bn of sustainable debt was raised in emerging markets, more than the combined amount in the preceding three years. This was led by Chile, Mexico, Brazil, India and Thailand.[iii]
Increased marketability: A key buying criteria for corporate lessees is energy efficiency as measured by the Power Usage Effectiveness. Additionally, green credentials provide a source of competitive differentiation that can make it easier for a property developer to secure anchor tenants who wish to meet climate pledges (such as hyperscalers Google, AWS, Microsoft Azure). Differentiation is particularly important in emerging markets where most property developers still consider sustainability as running counter to profitability.
Higher valuations due to lower regulatory risk: McKinsey predicts green data center asset values will increase by ~10% with climate transition.[iv] Investing in green initiatives now allow developers to futureproof for changes in building codes and city ordinances. Following developed market counterparts, policymakers in emerging markets are beginning to create enabling environments to promote adoption of green activities. For example, the Colombian government provides tax incentives for technical solutions such as insulation and energy-efficient air conditioning systems.
Which green activities/investments are NPV+ in emerging markets?
High energy consumption buildings already utilize improved caulking, air sealing, weather-stripping, low-E windows, smart meters, LED lights, better insulated walls, high efficiency HVACs and low-heat paint because the business case has been proven for years. Recent technological advancements have also made it possible for the following greening activities to improve a project’s Net Present Value.
1. Rooftop solar PV (Unlevered IRR: ~22.0%): Grid-tied PV systems are probably the most visible and widespread greening investment. Polycrystalline solar panel prices have dropped significantly over the past decade, making them NPV+ investments even without subsidies. The roof of a 20MW data center can support ~1MWp of PV panels.
Generating electricity onsite lowers reliance on grids with significant coal and oil plants. Unfortunately, a rooftop system generates less than 1% of the annual electricity consumption of a data center at full capacity. However, because solar panels shield a roof from the elements, they can increase the useful life of a roof.
2. Decarbonizing back-up power (Unlevered IRR: Over 23.4%): Power outages at high energy consumption buildings can cost thousands of dollars per minute and damage a developer’s reputation. To reduce risk, power is usually connected to multiple substations (and sometimes two grids) and co-located diesel generators for back-up. Diesel gensets have comparatively low upfront capex, fast response times and a robust fuel supply chain. However, carbon emissions are high and gensets are noisy, smelly, and polluting.
As data centers and cold storage facilities are located in urban centers, compliance to future regulations may necessitate switching to cleaner back-up power. Microsoft plans to stop using diesel units in its data centers by 2030 and is testing hydrogen fuel cells in a Utah facility. Google is piloting a large battery at its data centers in Belgium and Nevada. However, advancements in system density of li-ion batteries energy storage (“BESS”) are still needed for emerging markets developers to replace diesel gensets. Battery systems still take up too much space, in an industry where floor area and height are correlated with revenue-generating ability. Tesla’s li-ion BESS has a footprint of 53sqm per MWh. Back-up generators are sized to cover the maximum load of a data center for at least a few hours.[v] A 20MW data center with a 20MW/80MWh li-ion system would require over 4,000sqm (over 10% of a stand-alone data center’s gross floor area).
Given surging petroleum prices, replacing diesel back-up power is attractive as a service for use in data center clusters (not individual buildings) and special economic zones. The largest electronics manufacturers in emerging markets are offshore subsidiaries of multinationals. For these buildings, floor area is less scarce since factories purchase/lease hectares of land within master-planned special economic zones outside urban centers. A flow battery or hydrogen fuel cell (once green hydrogen supply increases) could provide a reliable zero-carbon alternative at a lower cost than diesel.
Special economic zone developers have a unique opportunity to provide Power Reliability (back-up power) to factories located inside their zones. In this context, BESS are NPV+ projects that can displace the diesel gensets of locator factories. Economic zone developers can earn revenue from locator factories through capacity payments while allowing factories to save on expensive diesel. See investment case for li-ion BESS in previous post
The ideal set-up for an economic zone developer is a hybrid system made up of li-ion BESS for short outages and Long Duration Energy Storage (“LDES”) for day-long or week-long outages. Li-ion and many LDES have response times equal to diesel gensets (10–20sec) and a low carbon footprint. Lazard predicts that adding storage capability to rooftop solar increases a PV system’s unlevered IRR to 23.4% — 27.4%.[vi] See intro to LDES in previous post
3. Clean energy procurement for prime power (Unlevered IRR: Over 20%): Among emerging markets, there are several countries with Retail Choice regulations. Large electricity users in India, the Philippines, Kazakhstan, Romania, Russia, Turkey, Ukraine, Argentina, Brazil, Chile, Guatemala, and Peru are able to choose which generators supply them power.[vi] For buildings sourcing energy from grids with over 50% of energy mix in coal and oil-based generation, this activity has the largest positive climate impact. In some markets, partial disintermediation of the distribution utility (paying only a “wheeling charge”) to lower tariffs is possible.
Geothermal and hydropower are the ideal clean energy source for uninterrupted power because both are baseload technologies that can operate in any weather. Global capacity of the two has decelerated markedly due to project siting constraints, long lead-times for development, and the relative attractiveness of intermittent renewables. Over the past decade, the world added ~270GW in generation capacity annually. However, only 0.51GW and 27GW of geothermal and hydropower, respectively, was added annually in those years.[viii]
In several of the above countries, clean electricity prices are still equivalent to the price of electricity generated by coal. This may change due to demand from large users who have made net zero commitments. Given anticipated increase in demand for baseload clean energy and the slow growth in supply, it is good business sense for high energy consumption buildings to sign long-term power purchase agreements to lock-in current rates. Because tariffs stay the same or are reduced, the unlevered IRR of a data center procuring green energy are at least base case project returns of 20%+.
4. Low-carbon concrete (Unlevered IRR: Over 20%): Concrete is used in the entire powered shell of these real estate formats. Waste CO2 (ie from a carbonated beverage manufacturer) can be mixed in with cement and aggregates in precast facilities or batching plants. Once injected, CO2 calcifies which reduces the cement needed for the concrete mix. This new mixture has 10%-20% less embodied CO2 and is generally sold at the same or similar price as traditional concrete. Low-carbon concrete provided by an Amazon and Microsoft-backed start-up is currently being used by data centers.[ix] However, market adoption in emerging markets has been slow due to real estate developers’ traditional low risk tolerance for new technologies. See previous post on decarbonizing cement and concrete in emerging markets
A 20MW data center can reduce embodied carbon of its structure by 960,000 tons by replacing traditional concrete with green concrete.
Because there is no or minimal incremental cost to a project developer, the unlevered IRR of a data center using low-carbon concrete mirrors base case project returns of 20%+.
Lastly, advances in Latent Heat technology (Long-Duration Energy Storage) could be applicable to cooling high-consumption buildings in the future.
Doing good is good for business
Buildings and construction are responsible for 39% of global carbon emissions[x] Greening high energy consumption buildings with new technologies can supercharge a property developer’s operating income. At the same time, sustainability credentials can lower financing costs, increase marketability, and improve asset valuations.
[i] IFC Edge Green Buildings. “Colombia: Green Buildings Accelerate from Zero to 20 percent of the Market in Four Years.” https://edgebuildings.com/the-transformation-of-colombias-green-building-market-from-zero-to-20-percent/ (October 29, 2021)
[ii] Neuberger Berman. “Is the Green Bond Premium Here to Stay?” https://www.nb.com/en/global/insights/nb-blog-is-the-green-bond-premium-here-to-stay (December 1, 2021)
[iii] BloombergNEF Sustainable Finance Database
[iv] McKinsey. “Climate Risk and The Opportunity for Real Estate.” https://www.mckinsey.com/industries/real-estate/our-insights/climate-risk-and-the-opportunity-for-real-estate (February 4, 2022)
[v] BloombergNEF. “Data Centers and Decarbonization” (October 14, 2021)
[vi] Lazard. Levelized Cost of Storage Analysis -Version 7.0 (October 25, 2021)
[vii] Oxford Institute for Energy Studies. “Liberalized retail electricity markets.” https://www.oxfordenergy.org/wpcms/wp-content/uploads/2019/12/Liberalized-retail-electricity-markets-EL-38.pdf (December 2019)
[viii] BloombergNEF capacity & generation database
[ix] PRNews. “ Compass Datacenters Announces Use of Carbon Cure Concrete.” https://www.prnewswire.com/news-releases/compass-datacenters-announces-use-of-carboncure-concrete-301061507.html (May 19, 2020)
[x] World Green Building Council. “Bringing Embodied Carbon Upfront.” https://www.worldgbc.org/news-media/WorldGBC-embodied-carbon-report-published#_ftn1
Disclaimer: This post reflects my personal views and not those of the International Finance Corporation, World Bank, or any other member of the World Bank Group