Self-Storage Real Estate and Financial Uncertainty: Perspectives for Facility Owners
Copyright 2014 by Virgo Publishing.
By: Ben Vestal
Posted on: 10/20/2012



 

This year has been marked by the political “rock and roll” of the election season, and it’s difficult to predict what the rest of the year or 2013 will bring. No matter which side of the aisle you sit on, if you consider the debt levels on which the U.S. economy is embarking with no debt-reduction plan in place, it’s obvious we’re moving quickly into uncharted waters. It’s also important to mention that Congress has received warnings in regard to the U.S. credit rating from groups such as Moody’s.

In light of the turmoil and uncertainty our country is facing, I’ll give you some thoughts on the self-storage real estate market that will hopefully provide some perspective for self-storage owners to consider.

The Market for Self-Storage Properties Today

The uncertainty of the economy, political leadership, interest rates and the current U.S. tax structure have had an impact (positive or negative) on the marketability of self-storage properties around the county, depending on your current situation. However, unlike the macro issues mentioned above, the adjustments to self-storage values have been more moderate and rational.

Self-storage facility prices per dollar of net operating income hit an absolute all-time high in about mid-2007. Buyers at that time would accept the validity of just about any projection and finance the project to the maximum allowed. The 2012 market has seemingly found equilibrium at levels that are 5 percent to 15 percent below the historic highs, although the spread between the top 10 metropolitan statistical areas (MSAs) and the rest of the country is greater than that of the 2007 market. This has created opportunities for the entrepreneur who can operate in smaller markets with a lower expense structure, employ more hands-on marketing, and use today’s technology to minimize the expense load.

The reality is most of the large deals done in major markets today are by investors and institutions with OPM (other people’s money). These institutional-type investors have access to less expensive capital than the entrepreneurial investor, and they don't look at acquisitions in the same way. For example, they don't evaluate an investment for protection of a current asset, protecting or gaining market share, the desire to enter certain markets, or the opportunity cost of putting or not putting the money to work today. All of this has led to a fluid transaction market where deals are being done in large and small markets nationwide.

What's the Big Question?

The real question is, what do interest rates, improvement in the economy and a change in the U.S. tax structure mean for self-storage owners and their property values? In other words, how do changes in the macro economy and the credit markets impact the value of self-storage properties and the owners’ flexibility?

By example, capitalization (cap) rates, the way in which self-storage and other commercial real estate is valued, and interest rates are inexorably linked. If interest rates go up, cap rates will ultimately go up as well, and vice versa. However, due to various market conditions, the link between the two is somewhat flexible as to the timing and magnitude. Think about the relationship between the two rates as being tied together by a rubber band that allows it to expand and contract somewhat, but the overall relationship remains strong and closely related.

The current low interest-rate environment has allowed the market to reach equilibrium and created an almost perfect environment for anyone thinking of buying, selling or refinancing. I know that sounds like a broker talking, but consider the following: Buyers can buy a great property and achieve cash-on-cash returns not seen in many years. Sellers today, on the other hand, can get near the highest price per dollar of income in the history of self-storage. And if you’re considering refinancing, you can lock in an interest rate at the lowest rate in 50 years. The real question is: How long will this all last?

Second, self-storage values will most likely stay relatively the same in the coming year if the economy continues to improve. It’s anticipated we’ll experience a 10- to 25-basis-point compression in cap rates over the next year. This is largely due to the current interest-rate environment with most of this compression in cap rates being enjoyed by the B- and C-class properties as investors continue to chase yield. However, we just as easily could see a 10- to 25-basis-point expansion in cap rates if we were to experience an increase in interest rates after the election.

Lastly, a change in the U.S. tax structure could be devastating to the after-tax dollars a seller will receive when selling a self-storage property, and not because the properties will be producing any less income than the year before or the value of the property will be less than today. I’m not an accountant and do not give tax advice, but I believe it’s worth your time to check with your accountant to understand the impact of an increase in capital-gains tax on your after-tax proceeds.

Clearly, any of these events could have a material impact on a buyer’s or seller’s investment. My best advice is that if you’re in the market today, it’s time to seize the moment!

Ben Vestal is president of the Argus Self Storage Sales Network, a national network of real estate brokers who specialize in self-storage. Argus provides brokerage, consulting and marketing services to self storage buyers and sellers and operates SelfStorage.com, a marketing medium and information resource for facility owners. For more information, call 800.55.STORE; e-mail bvestal@argus-realestate.com .