In the digital age, data is the new oil—and data centers are the refineries. These facilities store, process, and manage the massive amounts of information generated daily by people, businesses, and governments. With the rapid growth of cloud computing, video conferencing, AI processing, e-commerce, and streaming services, the demand for high-quality data center space has increased globally. This shift has made Data Center Real Estate Investment Trusts (REITs) some of the most sought-after vehicles in real estate and infrastructure investment.
However, one of the most critical decisions for any data center REIT is where to locate its facilities. The location not only affects construction and operational costs but also dictates network latency, access to clients, energy availability, tax incentives, and overall profitability. Traditionally, REITs focused on Tier I markets—major metropolitan areas with high connectivity and dense user bases. But in recent years, Tier III and secondary markets have gained attention due to shifting demand, lower costs, and increasing edge computing needs.
This article examines the strategic considerations that guide REITs when selecting between Tier I and Tier III markets, exploring the trade-offs, regional dynamics, and long-term trends that influence their decisions.
Understanding Tier Classification in Data Center Markets
In the context of data centers, “Tier I,” “Tier II,” and “Tier III” are not to be confused with the Uptime Institute’s tier standards for reliability. Instead, this classification refers to the market’s economic maturity, connectivity, and user density.
Tier I markets are typically large, primary cities that serve as data and network hubs. Examples include:
- Northern Virginia (Ashburn)
- Silicon Valley (Santa Clara)
- Dallas
- London
- Frankfurt
- Singapore
These locations have dense network access points, submarine cable landings (in coastal cities), and major cloud service providers’ presence.
Tier III markets, by contrast, are smaller cities or regions with emerging or developing infrastructure. Examples include:
- Columbus, Ohio
- Salt Lake City
- Phoenix (now bridging Tier II to Tier I)
- Riyadh, Jeddah, and Cairo in the Middle East and North Africa (MENA) context
These markets may have fewer direct fiber connections or cloud nodes but are often experiencing rapid data usage growth and benefit from proximity to underserved populations.
Why Location Matters for Data Center REITs
Data centers are not mere warehouses for servers. Their performance and profitability are tied directly to geography. A data center’s location influences:
- Latency: Proximity to users and fiber routes determines data transmission speed.
- Cost Structure: Land, labor, and energy costs vary greatly by region.
- Risk Exposure: Natural disaster vulnerability (earthquakes, hurricanes) can affect resilience.
- Energy Supply: Reliable and sustainable power is essential.
- Regulatory Environment: Tax incentives, zoning policies, and data privacy laws impact feasibility.
- Client Base: The type and scale of tenants—hyperscalers, enterprises, telecom operators—are often tied to the region.
These factors combine to shape the financial model of each facility and, by extension, the REIT’s returns.
The Dominance and Appeal of Tier I Markets
Tier I markets have long dominated data center development. Their appeal lies in several key advantages.
Network density and interconnectivity are primary. In cities like Ashburn or Frankfurt, dozens of internet exchanges, fiber backbones, and carrier hotels exist within short distances. This makes data transmission faster and cheaper.
Tenant concentration is another factor. Cloud providers like Amazon Web Services (AWS), Microsoft Azure, and Google Cloud have already established large campuses in these hubs, creating a network effect. Enterprises and managed service providers prefer being near these cloud zones for hybrid or multi-cloud strategies.
The availability of skilled labor and infrastructure support also make the Tier I market favorable. Data centers require not just servers and cooling systems, but also trained technicians, security personnel, and engineers.
However, these advantages come at a cost. Land prices in Tier I cities are high, often making horizontal expansion expensive. Power costs may also be higher due to urban demand. More importantly, competition is intense, and entitlement processes (such as permitting) can be time-consuming.
For instance, a REIT seeking to develop a 20 MW facility in Santa Clara may face years of permitting delays and high upfront land acquisition costs. Meanwhile, in a Tier III market like Salt Lake City, the same facility might be built faster and more affordably, albeit with fewer immediate interconnection options.
The Rise of Tier III Markets
Tier III markets are emerging as attractive alternatives for several reasons.
One driver is the shift toward edge computing. As real-time applications like autonomous vehicles, smart cities, and industrial IoT grow, there is a need to process data closer to where it’s generated. This makes Tier III and even rural edge locations viable options.
Another trend is the decentralization of data due to data sovereignty laws and privacy regulations. Countries in the Arab region, for example, are implementing rules that require data localization. This has sparked new demand for data centers in cities like Riyadh, Abu Dhabi, and Cairo.
Lower costs and land availability are also important. In Tier III areas, REITs can acquire larger plots at lower prices, allowing for scalable campuses and operational flexibility. Power and labor are also more affordable, improving the overall return on investment.
Additionally, local government incentives in developing markets are becoming more common. Tax holidays, energy subsidies, and land grants are being offered to REITs and hyperscale developers willing to bring digital infrastructure to underserved regions.
Despite these advantages, challenges remain. Tier III markets often lack the fiber density and network ecosystems of Tier I hubs. Building reliable power systems may require partnerships with utilities. Attracting large tenants also takes longer, particularly if the region lacks a mature enterprise tech ecosystem.
Comparative Strategic Considerations
When choosing between Tier I and Tier III markets, REITs evaluate a range of factors. These considerations are rarely about one market being better than the other—instead, the decision depends on the REIT’s strategy, capital resources, tenant profile, and risk appetite.
For REITs focused on long-term, low-risk income, Tier I markets may be preferable. The stable demand, high occupancy rates, and established customer base create predictable revenue streams. This is particularly attractive to institutional investors seeking dividend reliability.
On the other hand, growth-oriented REITs or those with a development pipeline may pursue Tier III opportunities where they can achieve higher yields. Building in emerging markets or secondary cities involves more upfront risk but offers the potential for higher returns if demand materializes.
Some REITs adopt a hub-and-spoke model, combining Tier I and Tier III assets. In this approach, Tier I cities serve as central hubs, while Tier III locations act as edge nodes, extending network reach and serving regional customers. This model is gaining popularity in the Middle East, where large REITs are establishing metro-core data centers in Dubai while expanding edge nodes in Riyadh, Dammam, and even cities in Oman and Egypt.
Case Studies and Regional Dynamics
In the Gulf Cooperation Council (GCC), the demand for cloud services, video streaming, and e-commerce is growing rapidly. Several REITs and private developers are building or acquiring data centers in cities outside of traditional Tier I hubs like Dubai or Abu Dhabi.
Saudi Arabia, for instance, is investing heavily in digital infrastructure under Vision 2030. Riyadh and Jeddah, while not yet global Tier I markets, are rapidly evolving and receiving REIT and hyperscaler interest.
In Egypt, Cairo is becoming a focal point for North African data traffic. With its large population, growing fintech sector, and undersea cable routes, REITs see potential in building facilities there, despite challenges in power reliability and regulatory navigation.
Europe provides another example. While cities like London and Frankfurt remain Tier I giants, many REITs are now investing in cities like Madrid, Warsaw, and Milan to meet regional data growth and diversify from oversaturated hubs.
In the United States, cities like Phoenix and Atlanta were once Tier III or Tier II markets. Now, due to a combination of favorable land prices, tax incentives, and growing local demand, they’ve become almost Tier I equivalents. This shift shows how quickly market status can change.
Sustainability and Power Availability
Regardless of tier, power access is a non-negotiable factor. Data centers are extremely energy-intensive, and the availability of stable, affordable electricity is critical. REITs consider:
- Grid reliability
- Access to renewable energy sources
- Utility partnerships
- Carbon reduction goals
In Tier I cities, power grids are often congested, making it hard to secure new capacity. In Tier III markets, while power may be cheaper or more available, building the necessary infrastructure (transformers, substations) may take time.
Sustainability is also influencing site selection. Many REITs have adopted ESG frameworks and seek to locate facilities where renewable energy is accessible. This makes certain Tier III markets with hydropower or solar potential more attractive, especially in regions like North Africa and the southern US.
Future Outlook and Emerging Trends
The line between Tier I and Tier III markets is becoming increasingly blurred. As fiber networks expand, and hyperscalers distribute their workloads more evenly across regions, Tier III cities may rise in importance.
Emerging technologies such as 5G, AI, and blockchain are pushing data closer to the edge, making smaller markets strategically relevant. Moreover, geopolitical shifts and new data localization policies will continue to shape where REITs invest.
In the MENA region, international partnerships with hyperscalers, submarine cable expansions in the Red Sea, and sovereign digital initiatives are likely to drive REIT investments into new cities over the next five years.
Conclusion
Data Center REITs are navigating a dynamic environment where choosing the right location is more critical than ever. Tier I markets offer network richness, tenant density, and low-risk revenue—but at high capital cost and with increasing competition. Tier III markets provide lower costs, access to new populations, and development flexibility—but with greater risk and longer ramp-up periods.
Ultimately, the most successful REITs are those that blend deep market analysis, tenant alignment, and infrastructure foresight. By building diversified portfolios across Tier I and Tier III cities, they position themselves to serve both today’s cloud giants and tomorrow’s edge computing needs.
As digital demand grows across Arab markets, from the GCC to North Africa, REITs that understand regional dynamics and deploy capital strategically will capture value and shape the next phase of real estate and technology convergence.
