State of the Self-Storage Industry 2010, Part I: Real Estate
|Copyright 2014 by Virgo Publishing.|
|By: Amy Campbell|
|Posted on: 01/11/2010|
To say 2009 was a rough year for businesses is an understatement. While some self-storage operators did well during the past 18 months due to changes in the lives of consumers, most still felt the fallout of the recession. Lower occupancy rates, abandoned units, higher unit turnover and concessions became the norm for many.
Yet self-storage fared better than most commercial real estate, particularly hotels and office complexes. In fact, the four real estate investment trusts, often considered a barometer for the industry as a whole, reported better than expected third-quarter operating results.
Now, everyone is looking at 2010 to be the turnaround year. New construction will likely remain slow, and facilities will need to aggressively market themselves to stay on top. However, many operators and other professionals have a positive outlook.
In this three-part series, Inside Self-Storage asked experts in industry real estate, finance, development, management and marketing for their insight to today’s market. Part 1 delves into real estate, examining how the economy has impacted the buying and selling of self-storage properties, trends in cap rates, and what’s on the horizon. Our experts are:
What’s the state of today’s self-storage real estate environment?
Barry: We’re seeing more owners who considered selling their facilities decide to retain them, unless they have a need to sell. Owners feel they’re not getting the value they believe their property is worth. Two often repeated themes are they want to see where the economy is heading and what policies are proposed or passed by the new administration and Congress.
Chiswell: The answer depends on your perspective. If you have a loan coming due and can only get a 60 percent loan-to-value mortgage—coupled with a low-ball appraisal—things look bleak. You realize you can’t sell it quickly for what you feel it’s really worth.
On the flip side, some facilities are still operating at 85 percent physical occupancy. Operators have given up some pricing power in increasing rents, and many are involved in heavy discounting to keep renting units. I’m not sure just how long it will take for our industry to regain that price elasticity in many communities.
Kliebenstein: We have several factors affecting our industry: a weak economy that’s generating lower occupancy and declining rental revenues; reduced consumer confidence that translates into reduced discretionary spending, where often storage is seen as an unnecessary expense and eliminated; and a greater than ever number of properties in the market competing for fewer tenants.
Some good news: The willingness of lenders to work with borrowers on loan modifications to salvage ownership or transfer of ownership, and real estate investment trusts are able to raise capital and show returns through improved operations, such as expense control, debt restructuring, stock buy backs, etc.
With that said, self-storage continues to outperform other commercial real estate assets. Revenue of the self-storage REITS are only down 5 percent to 10 percent through the first three quarters of 2009. This is far better than some other commercial real estate asset types. We have started to see a re-emergence of confidence from the buyers, and the spread between the asking price and what buyers are willing to pay seems to be narrowing.
The good news is even though owners are worried, self-storage facilities are outperforming all other types of real estate in this down market due, in part, to the uniqueness of storage demand. Unlike demand for other property types, the demand for storage is partly driven by the disruptions in peoples’ lives caused by things such as a job loss or home foreclosure.
Barry: It’s true that sales volume is off more than 50 percent from 2008 levels for all the reasons just discussed. We believe, given the existing federal, state and local budget deficits, future tax legislation will be less favorable in the coming years. Also, more than $40 billion of self-storage loans will be maturing in the next five years.
This heavy supply of loans to be refinanced in a tight lending environment will also not help valuations. We’ll see a greater number of motivated sellers, more properties on the market, and more closed transactions. There are buyers who have cash or can get financing on today’s terms, and they stand to benefit.
Loan modifications continue to allow workouts between borrowers and lenders to prevent short sales, bank-owned real estate dumping, distress sales and other value-killing, toxic loan and asset disposition. Once the distress sales have run their course and cap rates begin to strengthen as the result of normalized real estate sales, values will increase and lender confidence should return.
Once residential values return and stronger sales occur, people will begin to move, and that will boost the self-storage business, increasing occupancy and allowing supply and demand to function at “normal” levels, ultimately producing higher rental rates through yield-revenue management tools.
We’re seeing deals done on trailing 12-month net operating income, and there’s little value placed on vacant space and expansion land. We will start to see some increasing velocity in transactions over the next six to 12 months, but it will be more in line with the industry averages over the last 15 to 20 years.
The majority of today’s investors, on the other hand, have been sitting back and waiting for owners to either become realistic about values or be forced into selling at depressed prices. Thus, there’s a wide spread between the bid amount and the asking price, and there have been few transactions.
Barry: A year ago, transactions were still closing at cap rates between 7.5 percent and 8 percent for class-A facilities. These same properties are now trading closer to 8.5 percent, with many properties offered at much higher rates. Long-term cap rates for self-storage are around 10 percent, so on a relative basis, owners still have good value in their properties.
It’s certainly not the top of the market anymore, but it’s a lot closer to it than the bottom. We expect values to continue to decline for a couple years. Everyone wants to buy at a 10 percent cap, so we’ll see increased activity in the 9 percent range for those who would like to put money to work, find a property in their geographic footprint, and understand that no one can pick a market bottom.
Operators are going to have to continue to be more resourceful to create increased NOI to substantiate their asking prices. The market will recognize tougher underwriting requirements, which may include salary adjustments, allowance for property-tax adjustments, insurance limits/coverage to value alignment, professional management fees, and replacement reserves.
The cap rates over the last three to six months have started to narrow, and we’re starting to see transactions in the well-occupied, well-maintained and demographically superior locations in the 8 percent to 10 percent range. This is a more in line with historical averages and is most likely where cap rates will be for the foreseeable future.
The most significant consequence of the current investment market conditions is the realization on the part of owners and investors that not all facilities carry the same risk, and thus, one cap rate does not fit all. Asking someone what the cap rate is for self-storage today is like asking them what a house costs. There are too many variables to allow a single answer to the question.
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