An Open Letter: Self-Storage Real Estate in This Economy
Copyright 2014 by Virgo Publishing.
By: Michael L. McCune
Posted on: 03/28/2009



 

I am writing this letter to give you my unvarnished thoughts on today’s real estate market and what I believe to be a self-storage owner’s options. These options are difficult and limited because the market is also unusually tricky.

I got into the real estate business in 1971 and have been, for the most part, happily and profitably engaged for some 37 years. Of course, there were periods of credit crunches, high interest rates, three serious recessions, savings-and-loan debacles, overbuilding and a significant period of very high inflation. Each one of these difficult times ultimately ended with a resolution, but not without some personal pain and, in the case of some of my real estate colleagues, serious negative consequences. 

As 2007 ended, I began to think there was something quite different about this “slowdown.” It occurred to me that the real estate market that had preceded the now-accelerating decline was dramatically out of line with any previous market. This boom of excesses was beyond the scope and magnitude of anything I had seen in the past. Prices were at record highs both nominally, and more disturbing, in relation to the incomes of the properties (i.e., extremely low cap rates).

Likewise, every property type was involved in this bubble. Exacerbating the problem was that usual financial underwriting standards were simply discarded and loan amounts were ridiculously generous; interest rates were low and often recourse was not required. The recovery would be more difficult this time because there were more causes of the problem. While my experience told me that, as usual, everything would work out with a little time, my instincts were much less sanguine. My instincts are now proving to have been more accurate.
 
The Real McCoy

This period of contraction, either directly caused or materially aggravated by the excesses of the entire real estate market, has resulted in the worst economic situation in living memory. This is the Real Mccoy! It's also clear that in the end, the fortunes of real estate will bear an outsized portion of the destruction of wealth because of the continued decline of real estate values (rising cap rates) and the lack of liquidity in the financial markets. Given the magnitude and diversity of this problem, it will not be solved quickly―in years, not months! Unfortunately, I am not alone in this assessment, but I do sincerely hope I am wrong.

The circumstances of this debacle leave self-storage operators few options and many challenges. Being unprepared is not  good.  My experience tells me owners have three choices.

Option 1: Batten down the hatches. If you want to hold on to your property for the long pull, the questions you must consider are:

  • Are you willing to hold the property for five years? 
  • Do you have solid financing currently in place for a contractual period of at least five years?
  • Do you have liquid resources to cover the debt service in the event your revenue declines 20 percent?
  • Are you among the five most competitive properties in a 3-mile radius?

If you can’t answer yes to these questions, you will have a serious problem reaching your objective of holding the property for a long period. Opportunities to refinance a loan are scarce in today’s world, and the terms will be difficult as to rates, adequate loan amounts and recourse. Your risk of not having enough loan term or staying power in a credit crisis and a seriously decaying economic environment is high.

If your current loan was made in 2002 through 2006, it is highly probable the property could not be appraised at a value that would yield the same loan amount as your current loan amount. This is because the loan-underwriting standards have gone from extremely lax to impossibly stringent. Remember, many loans have personal recourse and there are significant tax impacts on the “forgiveness of debt” in a foreclosure. If your answers are “no” to any of these questions, try Option 2.

Option 2: Move on. If you are thinking of retiring, lowering your risk, concerned about your market or just want to take it easy, then maybe you should think about selling. The necessary questions to answer include:

  • Are you willing to sell at the market price or wait several months so you can?
  • Do you believe prices are down at least 20 percent or more from the highs in 2006? 
  • Does your loan not have a “lock-in” that prohibits a sale?
  • Do you understand cap rates have gone up dramatically and generally range from 8 to 11, depending on the location and property?
  • Are you willing to pay the taxes?

Once again, the right answer is yes! In summary, the serious buyers are scarce, almost always knowledgeable about self-storage and, for the foreseeable future, are looking only for projects that are attractively priced. Further reducing the number of buyers is the availability of financing in a diminishing loan market.

Additionally, there soon will be foreclosed properties on the market that will add a new and detrimental dimension to the market competition. The net result is if you expect to sell in today’s market place, you must be aggressive in pricing, patient and emotionally ready to recognize the market as it is. If any of your answers are “no,” you may want to think about Option 3 or return to Option 1.

Option 3: Remain in denial. Denial, by simple default or negligence, is often a popular choice when presented with rather stark and limited options. By any standards, the first two options are more difficult and denial is easier—for now. However, the other two options give you some ability to protect the fruits of your investment and labor and will likely improve your future options.

Experience speaks to me on denial; the words that come to mind are worry, more worry, recrimination, angst, helplessness and guilt, to name a few. Thoughtful action is always more productive than worrying about doing nothing!

Good self-storage brokers can help you understand the market and assist you in buying or selling properties. Although they can't change the market, a good broker will work with self-storage owners to find the best solutions in today’s challenging environment.
 
Michael L. McCune is president of the Argus Self Storage Sales Network, a self storage real estate brokerage and development company based in Denver. Argus also operates www.selfstorage.com, a marketing medium for owners in the self-storage industry. For more information call 800.55.STORE.