Japan real estate and data centers have found plenty of common ground in the past 18 months. Geographically and sectorally, Japan’s commercial property and global data center real estate have become two of the hottest international asset classes. The wider real estate space has attracted investors from diverse corners and on the data center side, drawing the attention of strategically minded operators looking to tap the vast potential of the third largest economy and its high-tech environment.
A question we receive often is why Japan’s data center market is experiencing significant growth now, given the size and maturity of the economy and its population. Primarily, we see the surge in data center demand driven by the increasing need for cloud computing, AI requirements, outsourcing, and data onshoring. As a result, the market has grown rapidly over the past seven-to-eight years and is projected to continue expanding at a rate of approximately 10% to 20% annually. In more obvious terms, mid-term compound annual growth will position Japan as one of the fastest-growing data center markets globally for the foreseeable future, which will have implications for power, real estate and capital.
For many eyeing the market, some legacy issues have led to the recent surge. In Japan’s data center market from the 1990s to the 2010s, companies typically operated their own computers (servers) for their propriety use (on-premises systems). These data centers were often located in offices or other locations with convenient transportation for easy access by the company’s IT personnel.
However, the legacy started to wane about a decade ago. Around the mid-2010s, the development of modern data centers for hyperscale operators commenced at a large scale. Data centers for cloud computing services, such as Software as a Service (SaaS) and Platform as a Service (PaaS), were intensively developed within 30 km to 50 km of the center of Tokyo and Osaka.
Proximity to these large cities, where the population, economy, and IT equipment are concentrated, were driving factors for meeting latency requirements. The lack of data centers capable of meeting the demand for cloud services stimulated new development.
On the other hand, urban data centers that focus on communication quality, such as edge data centers, have not been developed in large numbers until around 2020. In Japan, there were already many small data centers in urban areas due to legacy, and these may have absorbed the demand. However, with the increase in digital demand, the development of urban data centers has become more active in recent years.
In the past couple of years, there were several reports of data center developments in rural areas, including Hokkaido and Kyushu. Operators announced data center developments utilizing renewable energy in Ishikari, Hokkaido, and Softbank announced a 300 MW data center development in Tomakomai, Hokkaido. Hyperscale operators are also expanding in Kyushu, Hiroshima, and Wakayama. These data centers being developed in rural regions have relatively relaxed latency requirements but higher power requirements, focusing on AI deep learning services.
Data centers vary widely in location and facility requirements depending on their intended use. From a real estate investor’s perspective, a deep understanding of the location and requirements of each data center is critical because investment risk characteristics (size, horizon, etc) depends on those requirements. The challenges in today’s data center development are diverse and ever-changing; most recent challenges includes the length of time it takes to get power and the increased cost of construction.
While the digital industry is a fast-growing sector, the pace of change is rapid. In order to ensure the timely and successful development of data centers, which are the key infrastructure of the digital industry, it is vital that the digital industry, the real estate and construction industries, and other related industries work closely together.
Reliable and sustainable power supply is crucial for data center locations. Japan benefits from a robust power infrastructure, ensuring a stable power supply and reducing the risk of downtime. However, power connectivity wait times have increased to between 10-20 years compared to only one-to-two years around five-to-ten years ago.
As new data center facilities mature and stabilize, opportunities for further investment in the sector emerge. While transactions have been limited due to the scarcity of stabilized data centers in the market, investments in stabilized centers in Japan will be highly contested due to robust occupier fundamentals, increasing demand and construction cost constraints.
Capital investment plays a vital role in the growth and expansion of Japan’s data center market. Investors, often driven by international investors with joint ventures with domestic developers and power companies, have diverse options, including real estate investment in purpose-built data centers, infrastructure funds focused on power and connectivity, and private equity participation in data center operators and developments. Each investment avenue offers distinct advantages and considerations, with potential variations in risk, returns, and investment horizons.