The author Arthur C. Clarke famously said that any sufficiently advanced technology is equivalent to magic. There is a lot of magic in the air these days, with dramatic advances in AI being announced almost daily. However, AI magic does not appear by waving a wand but rather through significant amounts of computing power and data storage capacity.
That capacity has been supported by rapid growth in data centres
located across North America—growth which shows no signs of
stopping. Traditional development hubs in the United States such as
Northern Virginia and Phoenix are being supplemented by new growth
areas in Salt Lake City, Dallas and Las Vegas. Across the
continent, developers are looking for inexpensive land, access to sufficient utilities
and friendly local governments.
What developers really need, however, is access to capital. A multitude of those capital sources are emerging, including traditional project finance teams, real estate finance shops and private credit funds. The approach taken to underwriting and structuring this credit can vary based on which desk the originator sits at within a given financial institution. As a result, data centre financing tends to look like a hybrid of real estate, project and corporate finance.
The role of SNDAs
The one constant in data centre finance is the importance of the underlying customer agreement to underwriting and ongoing credit quality. In this way, data centre finance is similar to financing an office building with a high-quality anchor tenant—the payments made under that lease are the primary driver of the borrower's ability to satisfy its obligations to the lender. As a result, lender groups (regardless of their thematic approach to underwriting and structuring) will often require the customer to sign a subordination, non-disturbance and attornment agreement (SNDA), which establishes a direct contractual link between the lender/security agent and the customer.
SNDAs seek to achieve the following: (i) subordinate the underlying customer agreement to the lender's lien, (ii) lender agrees to not disturb the customer/tenant's use or possession of the property in connection with a foreclosure and (iii) the customer/tenant agrees to attorn to the new owner of the property following a foreclosure, maintaining the status quo at the property.
SNDAs are extremely common in real estate finance, but there are certain elements of the data centre SNDA that are distinct from "market" on a real estate financing. Market participants should be sensitive to these important distinctions as they negotiate SNDAs in this context.
Qualified Operator requirement
While a "traditional" SNDA would provide the free ability of the lender/agent or its designee to foreclose on the underlying asset, data centre SNDAs will typically include a requirement that the property be owned at all times by (or the owner must engage) a "Qualified Operator" (i.e., an entity that has a certain number of years of experience owning and operating data centres or that owns and operates a certain number of square footage or leasable megawatts). Customers have a vested interest in their supplier being technically savvy enough to deliver their required uptime and otherwise manage their facility appropriately. Given the fewer options in the market to manage these facilities than a typical office building, it is even more important to firmly require that a steady hand is always at the helm.
Notice and cure
An SNDA typically provides that the lender receives notices of all defaults under the underlying lease and an extended opportunity to cure landlord defaults so that the lender has some ability to protect their primary collateral (the lease) from being terminated. In a stabilized commercial lease, many landlord defaults can be cured by writing a cheque (for example, a requirement of landlord to make a TI payment or to perform maintenance or repairs at the property).
Because the list of landlord defaults in a data centre lease could be technical in nature (such as a failure to maintain a redundancy requirement), lenders will often request a tolling of the cure period (and the tenant's right to terminate) during any period in which lender is pursuing a foreclosure of the property in order to cure the default. This is often heavily negotiated given that it requires the end user to sit on their hands for a potentially indefinite amount of time. A compromise that requires services to be restored to some minimum standard during the tolling period is often achieved.
Conclusion
Because of the hybrid nature of data centre financing, concepts from different realms have merged to create the market standard approach. This is very evident with SNDAs, which retain their basic nature as part of real estate financing transactions but with a few important distinctions for this asset class. While in some ways data centre customers, especially hyperscaler users, have more leverage than a typical real estate tenant, the technical nature of landlord obligations requires that lenders protect their interests as well in a downside scenario.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
