Billionaire real estate developer waves red flag over data centers

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Fernando de Leon, founder of Leon Capital Group, started a small lot development company in 2004 with $100,000 and turned it into a $10 billion business, focused mainly on commercial real estate. He did that, he says, by predicting distress, watching the source of capital and leaning on his Harvard degree in evolutionary biology. 

While others lost their shirts in the great financial crisis, De Leon began to make his fortune. He left a job at Goldman Sachs to start his own business and was doing some deals in residential lot development. A year in, he said, he saw some of the early indications from subprime mortgages and overbuilding that this was going to be, “a difficult cycle change.”

“We basically said, look, we see things here that are fundamentally unsound. We’re going to take these property positions and sell them, and then kind of wait and see what happens,” De Leon told Property Play.

“We divested, we brought back some liquidity, and then we sort of waited, and then in 2008 to 2012 we became fixers. We became people that were able to talk to banks, to life insurance companies, to businesses that had loan exposure, and we were able to solve problems for them,” he said. 

De Leon said he turned around projects that had stalled and become problematic for lenders, experience he now says informed his thinking in the early years of the pandemic. 

“In 2021, we sold a great deal, several billion dollars of real estate because prices were high, and that was a function of low interest rates and euphoria and bad incentives in the market,” he said. “Part of it is understanding where the capital is coming from. You begin to see participants in the market that shouldn’t be there … and when they match up and that funnels through the supply chain, you begin to see distortion and pricing.”

Now, De Leon said, he’s seeing the same red flags flying over data centers. 

While big players like Blackstone, KKR and Bain Capital are buying in, De Leon said he is sitting out. 

“The thing that I can’t quite square is the data center play. I look at a data center that’s $10 billion right? First of all, there haven’t been any exits above, you know, $4 billion or $5 billion, you haven’t seen comps, so that worries me quite a bit,” he said. 

“Then I see large technology companies, the largest companies on the planet, with $4 trillion market cap, saying, ‘I don’t want to own this asset. I don’t want to have this on my balance sheet.’ So I ask, Why? Why doesn’t the largest company in the world want to own its own asset?” De Leon said. “The AI business is everything for them today, for the large hyperscalers, and so they’re saying, ‘No, you build it, you finance it.'”

De Leon surmises that what is inside these data centers, the technology of artificial intelligence, will quickly become obsolete. AI, after all, is designed to make everything more efficient, including itself. And the value of the centers is not the four walls, but what’s inside. 

These 15- and 20-year leases that developers are relying on, he suspects, are “swiss cheese” leases – as in, full of holes in the agreement over time.  

De Leon said his biggest concern is that big private capital investors are getting the money they manage from things like pension funds for teachers, police and firefighters.

“When they say, ‘I’m going to own this asset and lease it back to one of the hyperscalers,’ they’re putting other people’s money at risk,” he said. 

De Leon started in the real estate business as a teenager, working as a translator for a local Texas developer. Instead of getting a salary, he asked for equity in a project. And rather than getting a degree in business, he chose evolutionary biology, because understanding people is good business, he says.

“It was prescient. I mean, it turned out to help me make decisions about organizing companies and leadership, building businesses,” De Leon said. “I think some of these things are about incentives, right? Basic commercial interaction between human beings is about incentives.”

He said that’s particularly true in industries where there are well established players. 

“You always find a status quo group of incumbents that are set up, and they have certain advantages,” he said. “Understanding them from a sociological standpoint, that gave us some insight into saying, ‘OK, this business should compete on this basis. This is where we can win,’ kind of seeing around the corners.”

De Leon said he’s excited about how much more capital is coming into commercial real estate – from wealth firms, family offices, sovereign wealth funds and pensions. 

“When the allocations to real estate go from 3% to 6%, that number means that there’s like $4 trillion more of capital that is chasing a finite number of real estate assets,” he said. “When that happens, you see an oversupply of capital, you’ll see price appreciation for fundamentally sound real estate assets. And so I think the story of the next 10 years will be that the real estate capital markets will grow 10-fold.”