While the data center craze has exploded over the past decade, COVID-19 accelerated this growth to new levels. With a significant portion of our global workforce continuing to work from home, much previous “in-person” interaction has been driven online. The need for data centers to support increased internet traffic, offer collaborative software for businesses, and maintain data security has been and continues to expand at record rates.
That’s not to say challenges for data center operators do not exist. As 40-year-high inflation weighs on consumers and economists debate recession signals, advertisers have been tightening their purse strings, which could spur data center investment. Additionally, shortages of developable land and power, along with worsening supply chain disruptions, will likely result in slowdowns in new construction as data center inventory becomes increasingly scarce.
Nowhere are these industry evolutionary changes more apparent than in Virginia, home to the largest data center market in the world, with more than 150 data centers and millions of square feet of data center space. Approximately 70% of all internet traffic runs through Northern Virginia. The most notable local jurisdictions (Fairfax, Loudoun, and Prince William counties) historically have imposed the highest real property tax assessments to data center owners of anywhere in the country. Further, each local jurisdiction’s assessment methodology has been disparate, so there has been little uniformity or consistency.
One notable flaw involves embedding non-realty value in a real property tax assessment. In a typical fully built-out data center, approximately 75% of the development cost is for data center infrastructure equipment or data center fixtures. This includes electrical, mechanical, and HVAC equipment (e.g., emergency power generators, power distribution units, specialized HVAC, water tanks, and similar equipment). Without these fixtures, a data center resembles an industrial shell similar to a warehouse.
Historically, the tax treatment and valuation of this equipment has varied widely across localities, leading to significant uncertainty and inequities. Finally, after years of public outcry, local legislation was passed earlier this year that directs data center fixtures to be assessed utilizing the cost approach (rather than income) for determining fair market value. The envisioned benefit to taxpayers includes 1) more predictability; 2) more uniformity; 3) accounting for physical, functional, and economic depreciation; and 4) ensuring intangible business value is excluded from real estate value.
Although the new law has been codified, it remains a mystery as to how local assessors will implement this new legislation into practice. At no time is diligently reviewing one’s assessment more critical than now. The Virginia tax experts at Ryan are closely monitoring the process and conversing regularly with local tax assessors and are ready, willing, and able to assist data center owners or operators in reviewing their property tax assessments to ensure exposure is limited to no more than their fair legal share.