Starwood Capital Group Launches Digital Ventures Data Center Platform

The artificial intelligence gold rush is having one of its first “picks and shovels” moments: data centers.

Last week, Starwood Capital Group, Barry Sternlicht’s $115 billion AUM real estate-focused investment firm, announced the launch of Starwood Digital Ventures, a dedicated platform for the group’s data center investment strategy.

Originally published in the January 23rd edition of Transacted.

Blackstone is growing its AUM with a new focus on wealth management products

The launch builds on Starwood’s previous work in the space, having deployed more than $8 billion to data center development over the past five years—making it one of the largest privately held developers in the U.S. and E.U.

Starwood’s Growing Data Center Play

While Starwood Digital Ventures isn’t launching with its own fund, Starwood did say the platform will receive specific allocations from the firm’s other vehicles—the first time that the firm is setting aside a dedicated pool of capital for the strategy.

The first portion of that funding is likely coming from the firm’s Distressed Opportunity Fund XIII. Fundraising for the vehicle launched last year with a $10 billion target, and, at the time, Starwood said it would allocate 20 to 30 percent of that total to its data center initiative.

Despite the fund’s name, Starwood doesn’t plan on specifically targeting distressed data centers. Instead, it’s looking for a mix of new developments, acquisitions, and partnerships with existing operators.

Starwood hasn’t yet said which other entities would provide funding to the Digital Ventures platform alongside the initial $2 to $3 billion.

A Hot Market With More Yet to Come

It’s a strategy that makes a lot of sense: “Data Centers are seeing the strongest supply/demand backdrop, in favor of landlords, since the early days of the social media explosion,” says Jefferies equity research analyst Jonathan Petersen. “Supply constraints are limiting the ability to meet demand, and rents are rapidly rising as a result.”

Much of that is thanks to the emergence of resource-intensive artificial intelligence applications. And, while the AI boom is well underway, it’s probably still relatively early in the investment cycle.

Current demand is centered around the support of AI model training activities, with data center customers spending big to develop resource-intensive generative AI models. Behind the initial training spend, however, is the much larger AI inferencing opportunity, which could be more than five times the size of the training market.

In any case, the AI growth story also has a more nuanced impact on data center market dynamics than a simple increase in capacity utilization.

Historically, many data centers have focused on a co-location offering, in which enterprise customers can shift their existing workloads to a low-cost third-party provider (the data center). AI use cases, on the other hand, require more specialized infrastructure that can handle high-intensity workloads. They also require low-latency interconnectivity, or data centers that can provide faster connections thanks to their physical proximity to network-dense population centers.

“Fundamentally, supporting accelerating AI/ML adoption requires more power and cooling than much of the existing data center inventory can accommodate,” says commercial property consultancy Newmark. “Not all existing data centers lend themselves to retrofitting, catalyzing demand for new product in both existing and emerging markets.”

To industry observers, it’s about as close to a generational opportunity as you can get. Jonathan Schildkraut, an SVP at Compass Datacenters, believes we’re now seeing "an incredibly unique convergence of two data center investment trends." He adds, "Specifically, we are seeing improving returns on capital at the same time as the risk associated with capital deployment is falling."

It’s the most favorable set of conditions the industry has ever seen, says Schildkraur. "More capital than ever before, 70 to 85 percent of expected spend, is being deployed while attached to known and committed demand."

Starwood Not the Only Firm Getting Involved

Starwood’s new platform is the latest public commitment to the strategy, but it’s far from the only investment firm active in the space.

GI Partners, Brookfield, KKR, and BlackRock’s newly-acquired Global Infrastructure Partners have all been expanding their data center footprint.

That’s not to mention DigitalBridge, formerly Colony Capital, which holds six separate data center platforms in its portfolio. That includes 32-location Vantage Data Centers, which earlier this year received $8 billion in new equity funding from Digital Bridge, AustralianSuper, and Silver Lake (which had sold Vantage to DigitalBridge in 2017). At the time of the latest investment, Vantage announced plans to invest more than $30 billion in new capacity development.

EQT is also doubling down. The firm acquired data center provider EdgeConnex in 2020 via its EQT Infrastructure IV and EQT Infrastructure V funds. This month, it announced it was contributing yet more money through its sixth infrastructure fund to focus on the development of next-generation facilities—supporting what the firm believes is an AI-induced need for industry capacity to triple by 2030.

Digging Out of a Hole

Starwood will be hoping that the launch of its Digital Ventures platform can provide some welcome uplift as it fields criticism for lackluster performance in recent years.

Blackstone is growing its AUM with a new focus on wealth management products

With a disjointed post-pandemic real estate market (and higher interest rates), Starwood has had to foreclose on a number of properties across its lending portfolio.

In late 2022, the firm had a default of its own after failing to make a payment on an $800 million hotel portfolio loan. It eventually reached an agreement with creditors, though was forced to contribute additional equity.

This summer, Starwood also defaulted on a $213 million loan backing an Atlanta office building, whose vacancy rate had jumped from a pre-pandemic 13 percent to nearly 40 percent.

But, for Starwood Digital Ventures, the most pressing near-term problems will be standing up enough capacity.

Sam Hillier

Sam Hillier is a reporter at Transacted covering private equity and investment banking. He previously spent time as an investment professional focused on direct buyouts, as well as an earlier strategic advisory stint.