Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 597

What AI’s ‘Sputnik moment’ means for data centres

AI-related stocks sold off heavily on 27th January 2025 as news emerged about DeepSeek R1, a Chinese developed AI large language model (LLM). DeepSeek has asserted it can deliver performance comparable to U.S. developed AI models, such as ChatGPT, but at a fraction of the cost and with much less physical computing power required.

While there is some healthy scepticism towards certain aspects surrounding DeepSeek, advancement in its algorithm has been widely recognised by the tech community including the leaders of NVIDIA, OpenAI and Meta.

DeepSeek’s open-source program allows it to be quickly studied and adopted globally, and therefore, it could represent a step-change in resource intensity required for the continued development of AI. This has led investors to re-assess the bullish trajectory of demand for advanced computer chips (GPUs), physical infrastructure and power required for the build-out and training of AI models.

As a result, stocks ranging from chip manufacturers, utilities, data centre equipment manufacturers and data centre landlords experienced significant share price declines following the DeepSeek news.

Given our overweight position and broader interest in data centres, we provide here an outline of our current thoughts on the potential implications for the data centre real estate sector, with the caveat that there are still a lot of unknowns.

Potential negatives:

  • AI-related demand for data centres may not live up to previous bullish expectations as future AI model developments could become more resource efficient, requiring fewer advanced chips, less power and cooling, and less data centre capacity than previously anticipated.
  • The potential reduction in demand could eventually lead to oversupply conditions in data centres - although this is not anticipated in the near-term given significant supply bottlenecks and lengthy lead times for electricity grid upgrades, electrical transformers and air-conditioning components required to satisfy current demand levels.
  • Big tech companies could reduce capex on data centre build outs. While previously announced capex might continue in the short term, it may be re-oriented towards software development rather than hardware (AI training infrastructure). Nevertheless, on its earnings call on 29th January, Meta re-iterated its plans to increase total capex spending to US$60-$65 billion this year – including increased investment in generative AI.
  • Investor enthusiasm for AI-related stocks (GPU’s, data centres, utilities etc) since AI emerged as a significant demand driver two years ago, has pushed valuation multiples to elevated levels relative to other sectors.

Potential positives:

  • DeepSeek may have over-stated its efficiency, and as such, it may not prove to be as great a departure from current AI infrastructure needs as initially feared. DeepSeek’s capabilities benefited from US developed large language models, which muddies the claim that DeepSeek R1 was trained for <US$6 million. If R1 had to be trained from scratch, the cost would have been significantly higher.
  • There is a long history of technology efficiencies driving increased adoption and ultimately growing the total demand pool. Microsoft's CEO was quick to reference Jevons Paradox, the observation that improvements in resource efficiency often leads to increased, rather than decreased, overall consumption of that resource.
  • The emergence of cheaper and more efficient AI models could potentially spawn new entrants (previously precluded due to the significant upfront costs, sometimes referred to as the ‘money moat’ that benefited incumbent big-tech companies).
  • Cheaper AI development could speed up AI adoption. Greater adoption could drive greater AI inference demand, benefiting existing data centre owners located in major population centers, as they cater to end users requiring strong network connectivity and lower latency.
  • While DeepSeek is more efficient and its advancements are likely to be widely adopted, major tech companies remain focused on developing more sophisticated artificial general intelligence (AGI), which will likely still require increased computing power for both training and inference.
  • National security concerns and geopolitics could drive duplication of AI investment. DeepSeek's emergence may compel tech companies and governments globally to increase capex to further improve AI capabilities.

Location, location, location

Our conviction in data centres is predicated on the expansion of the digital economy across a broad range of use cases, not just AI. Admittedly, AI has attracted disproportionate attention in recent years thanks to the potential impact it could have on the economy and society.

The data centre industry is presently supply constrained for a multitude of reasons mentioned herein. No doubt those with current capacity are enjoying pricing power and the question now is how long this will last if the more immediate demand side has been dampened.

We also acknowledge that many players are trying to get entitlements (real estate planning and power) to bring on material supply in future years. Our exposures are focused on superior in place platforms that provide space to a multitude of users for a variety of IT use cases, located in major metropolitan areas where there is deep tenant demand and dense fibre connectivity.

This is in contrast to some of the more recent wave of proposed AI training data centres that are mostly being developed by private capital and, by necessity, are often located in more remote locations where there is available land, cheap power, and typically oriented to a single tenant user.

If there were a reduction in AI training demand, we believe the more remote data centres would be more negatively impacted.

Data centre rent hikes not just about AI

As illustrated in the following chart, wholesale data centre rents inflected positively in 2022, after a decade of declining rents. Context is important here as it is important to note that rents declined during that period despite solid demand from broader digitalisation trends including the shift to cloud computing.

The rental decline can mostly be attributed to conditions that were conducive to profitable data centre development including benign construction cost inflation, declining interest rates and, tangentially, declining real estate cap rates. Despite a competitive rental market, these conditions allowed data centre developers to maintain healthy profit margins even as rents were falling.

Wholesale data centre rents inflected positively in 2022 as most of these conditions reversed (construction cost inflation spiked, interest rates rose dramatically and real estate cap rates increased), coinciding with the emergence of large-scale AI as an additional demand driver, together with significant supply bottlenecks in securing power to data centre sites and lengthy lead times for certain building components including electrical transformers and air conditioning equipment.

Importantly, it was a confluence of factors that drove the inflection, not only the emergence of AI demand.

 

You can see the full version of Resolution Capital’s research note “AI’s Sputnik Moment” here.

 

Andrew Parsons is a Co-Founder and Chief Investment Officer at Resolution Capital, an affiliate manager of Pinnacle Investment Management. Pinnacle is a sponsor of Firstlinks. Resolution has launched the only active GREIT Fund in Australia (ASX:RCAP).

This article is for general information purposes only and does not consider any person’s objectives, financial situation or needs, and because of that, reliance should not be placed on this information as the basis for making an investment, financial or other decision.

For more articles and papers from Pinnacle Investment Management and affiliate managers, click here.

 

RELATED ARTICLES

DigiCo REIT and the data centre opportunity

US trip reveals inflection point for $6 billion global industry

The copper bull market may have years to run

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

Latest Updates

Investing

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

Shares

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Shares

The ASX is full of old, stodgy, low-growth companies

Eight of the ASX's top 10 stocks are more than a hundred years old, while in the US there's just one. It points to our market being filled with low-growth dinosaurs compared to the US where innovation and renewal rule.

Retirement

Time to review the family home's exemption from Age Pension test

Improving housing mobility in Australia is crucial for enhancing both individual well-being and the economy. Potential reforms include ensuring greater rental security and incentivising downsizing among older homeowners.

Superannuation

Death benefits from super don't need to be this complicated

This may surprise you, but a person's super balance does not automatically form part of their estate. A simple change could bring greater certainty to Australians, quicker payouts for families, and lower super fees.

Economy

The RBA deserves kudos for a job well done

Over the past few years, the Reserve Bank of Australia has been subjected to a blizzard of criticism. Yet, despite its flaws, it may just have engineered that rarest of beasts: the fabled soft economic landing.

Investing

Asia deserves a closer look from investors

As part of their global exposure, Australian investors typically allocate most to Developed Markets equities, and a smaller portion to Emerging Markets. This looks at the latter position and whether there might be a better way.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.