State of the Industry 2001
Copyright 2014 by Virgo Publishing.
By: Barry Morris
Posted on: 01/01/2001



 

State of the Industry 2001Will self-storage's good fortune continue?

By Barry Morris

After a slow beginning, the 1990s became a decade of unprecedented prosperity for the self-storage industry. New properties emerged in many markets, bringing with them burgeoning consumer awareness and acceptance of the product. What was once the domain of mom-and-pop operators, with rudimentary buildings shoehorned into remote industrial sites, has steadily evolved into a largely developer-dominated business with modern, amenity-filled buildings in prime retail locations.

It's not all glitz and glamour, though. With the prosperity comes perpetual concerns about oversaturation, occupancy rates, financing availability and other issues. After years of growth, current indicators point toward a possible slowdown, attributable to some or all of these factors and consistent with a general cooling of the U.S. economy.

By tapping the knowledge of some of the industry's most respected insiders, this article will examine the current state of self-storage and its outlook for the new year. Whether you personally remain optimistic or tend to side with naysayers, the following should provide a good cross-section of views for the self-storage industry's prospects in 2001.

The Recent Past

When the potential for money-making opportunities in the self-storage industry became common knowledge in the mid-1980s, developers scrambled to react. A building boom ensued, pushing capacity far beyond demand for the product. Brisk competition and low occupancy rates combined to produce rock-bottom rental rates--a scenario operators found not conducive to meeting their mortgage obligations.

This industry-wide slump continued into the 1990s, with occupancies falling to their lowest point in 1990-1991, and the industry itself hitting rock bottom from 1990-1992. Many facilities were repossessed by lenders, and property values fell from their peaks of the mid-'80s.

But consumer demand eventually grows to meet supply in real-estate business cycles--and sure enough, by the middle of the '90s, things began to circle back toward prosperity for the self-storage industry. Occupancy caught up with the abundant supply, while the nation's economy strengthened. Financing firms loosened their tight reins, and full-scale construction began again.

As the new millennium dawns, the self-storage industry's big picture is still a positive one. That's not to say, however, there aren't some potential bumps in the road. Will these bumps turn into gigantic sinkholes that will send the industry falling toward a repeat of the late '80s and early '90s? Probably not. But given this history, most in self-storage seem to be better prepared to deal with whatever changes may come to the marketplace.

The Inside View

No two opinions of the industry's current state are exactly alike. While there seems to be no concern about a return to the depths of a decade ago, there are a wide variety of views about exactly how strong the self-storage business was in 2000, or how it will be in 2001. Like the markets themselves, opinions are regionally driven.

"This past year has been very good--actually a better year than '99," says Maurice Pogoda of Farmington Hills, Mich.-based The Pogoda Companies. "In the areas where we are, the economy has been sizzling. We've experienced a continued building boom here that has helped the self-storage arena tremendously. We have so many areas in Michigan and the surrounding states that are doing so well, and it always helps self-storage when you have that kind of activity."

"There's more money in the economy now than there has been in a long time," says R.K. Kliebenstein of Coast-To-Coast Storage, based in Boca Raton, Fla. "And in a healthy, vibrant economy, people have more disposable income. They're spending more freely. For self-storage, as awareness of the product grows, more people are taking advantage of it. As long as the economy stays healthy, even though we're experiencing a lot of growth in the sector in terms of new development, we will continue to lease that space."

Others, such as Jon Reddick of Sentinel Systems Corp. in Lakewood, Colo., enjoy continued good fortune--but with an asterisk of sorts. "Things are looking better than ever--we just had the highest sales month in the history of our company," says Reddick. "Part of that is due to the international market. We're starting to build a real strong foothold in Europe, as well as Australia and New Zealand. I think the United States market is starting to slow down a bit. Before, it was incredible. Everybody was building or doing a project all the time, and I don't see that quite as much now. But on the international side of things, they're really starting to move. They're typically two or three years behind us with technology, so I think that's why. They're where we were two or three years ago."

But others, while not pushing the panic button, see things slightly differently. The wildly fluctuating stock market of the past few months, for example, is creating a less-than-clear financial picture. "Probably one of the major issues that's going to come around in the next year is the lack of financing that may be available to refinance facilities," says Mike McCune of Denver-based Argus Self-Storage Sales Network. "We're recommending to all of our clients that if they have a financing event in the next two or three years, they should probably tend to it now as opposed to later, when the financing may be more difficult."

A common axiom used in the real-estate market--"location, location, location"--could also play a role in a possible downturn, says one executive. "I see the industry starting to slow down, not because of desire, but because of quality sites not being available," says Jim Chiswell of Williamsville, N.Y.-based Chiswell & Associates. "The barriers to entry are increasing because the type of facility required to attract today's new customer, in my opinion, is much more of a retail site, requiring all the bells and whistles in terms of security, landscaping and ease of access. All these factors are obviously going to increase the per-square-foot cost."

Economics 101: Supply and Demand

With the proliferation of new properties in many parts of the country, the question of overbuilding and saturation of particular markets is always a legitimate one. Many operators, especially those who came into the business during the mid-1990s boom, launched projects with little forethought about location or market demand. "I've had some concerns about overbuilding, and I would share that to an even greater degree now," Pogoda says. "I know of so many more facilities coming out of the ground this year and so many that are site-plan approved and ready to go, where people are just lining up their financing."

Too often, according to Pogoda, overbuilding is the result of inexperienced developers entering the industry. "A cry that I've been lamenting for years is that there are many novices trying to get into the business who don't do their homework," he says. "People are picking locations that are subpar, and building facilities willy-nilly without seeing if the market needs them."

Mel Holsinger of Tucson, Ariz.-based Executive Self Storage agrees there is an abundance of overbuilt markets. "There are still some markets that have some opportunities, but I think those opportunities are closing very quickly as far as new projects being supported by existing markets," he says.

The strongest markets for new development are currently in California, says Mike Burnam of StorageMart, a Columbia, Mo.-based facility operator with locations in several major metropolitan areas. Conversely, Burnam sees a continued weakening in Phoenix--which had been a strong market for many years--as well as in larger Texas markets such as Dallas and Houston. But even when a market shows some promise, the realities of the marketplace often pose a problem. "Austin markets are a bright spot," he says, "but rental rates are so low it doesn't warrant additional new development except at the lower end of the spectrum."

Even when a developer does his homework and chooses a site most agree will be in demand, there's no guarantee it will happen overnight. "We have some micro-market areas within communities that have seen, over the last several years, a great deal of new growth," Chiswell adds. "It's going to take awhile for those areas to absorb that new space."

The abundance of newer properties not only creates excess capacity; some say it also creates a sort of class structure among properties, potentially making the older ones less appealing to the consumer. "New facilities are being built in areas where one or two operators have had it all to themselves for years, and their facilities--which are now 10 to 15 years old--have become dog-eared and tired looking," says Chiswell. "In many cases they haven't spent the money to keep their facilities looking sharp. That way they become very susceptible to that new kid on the block or one of the national companies coming in with their new prototype facilities, which are very retail-focused."

Development and Construction

To attract the increasingly discerning self-storage consumer, new properties must offer the latest amenities and conveniences, such as automated security, bank-card and AFT payment options, and activity on the Internet. "There's definitely more climate control, more amenities being built in--it's the trend that has been continuing through the late '90s," says Pogoda. "Cameras, individual door alarms--those kinds of amenities are much more prevalent now than ever before."

But the shiny trimmings incorporated into new facilities don't always overshadow older properties--at least not in areas served by Pogoda's company. "Because the markets have been so strong, it hasn't seemed to have had any great effect," he says. "These newer facilities have added to the market, but the older facilities are holding their own. When you have a downturn, the consumer, if he has a choice, is going to go to the nicer facility rather than the older facility. But when he calls up, most facilities are full. Consumers are taking what they can get."

As previously mentioned, site availability is becoming a greater barrier to entry into the self-storage business. If land isn't completely unavailable, its price often necessitates multistory development. A solution to this dilemma for urban areas has become known as "in-fill" construction, where developers go into downtown neighborhoods and either convert existing buildings into self-storage or demolish a building and put up a new facility on the land. Kent Greenwald of CB Richard Ellis Inc.'s Phoenix office referred to projects completed by a leading self-storage operator in the Los Angeles area. "When you look at the land price, you'd be astounded," he says. "But when you look at the rents they get and how fast they lease up, it's unbelievable."

Acquisitions

For movement of existing properties, a consensus of brokers' opinions suggests the market is leaning slightly toward sellers. "There's still an abundance of buyers in the marketplace," says McCune, "and there are more sellers as well. Right now it's a pretty equitable balance, and it's hard to predict exactly what's going to happen; but if the financing dries up, I suspect there will be a buildup of sellers as opposed to buyers."

Marcus & Millichap's Burt Gay adds, "From a broker's perspective, it's great--we're moving into equilibrium. Before, there were very few sellers and very many buyers. Now it's more balanced. Two years ago, because we had very low interest rates, we had very high prices. Much of the smart money sold then. Now the sellers are a little bit nervous with the stock market being precarious, and are coming out of the woodwork and being more willing to sell than ever before in the recent past."

After riding the wave of a seller's market, Dean Keller of Bancap Self Storage Group Inc. predicts there will be fewer aggressive buyers in the new year. "Right now we have far more buyers than we have properties available to buy," Keller says. "So any institutional-grade property--a facility of 40,000 square feet or above in a good metropolitan market area that's reasonably filled and reasonably located--is going to have buyers. Yet they still have return on investment requirements, so they're not willing to overpay for things."

Greenwald says sellers aren't flocking to him simply because the market favors them. "It seems there are a number of self-storage operators who are not really motivated to sell because they bought or developed their properties in the early '90s, and they've ridden the economic boom." He adds that there's much greater knowledge of the self-storage market now than there was 10 years ago. "I receive one to two calls a week from buyers who are not in the self-storage industry, but are terrifically motivated to buy buildings," he says. "But the majority of the self-storage transactions are still going between experienced operators."

Financing

Because of the problems experienced by the industry in the past, lenders are far more careful about what projects they finance. While this may make it tougher to acquire a loan in some cases, those with favorable business plans are still largely successful.

"There are many aspects of the financing arena still on the upswing and very positive for the industry," says Neal Gussis of Chicago-based Beacon Realty Capital. "A lot of fixed-rate mortgages are being offered in the low 8s right now and, on a relative basis to historical benchmarks, that's still very good financing for this industry.

"There are more banks than ever before that understand self-storage and are willing to look at it either on a local or regional basis," Gussis continues. "Conduits, or secured-type lenders, are still offering fixed- and/or variable-rate mortgages. On the downside, there are fewer of the secured-type lenders and their underwriting requirements are stricter than before."

The picture painted by Argus' McCune is somewhat less optimistic. "I think we're seeing a constriction of development finance about to happen, which is going to slow down the additional development of sites and new facilities in the next year," he says. "The FDIC (Federal Deposit Insurance Corp.) is putting some pretty strong constraints on many of the banks, and has identified several areas as being overbuilt in terms of real estate in general, which will impact self-storage."

Since banks will often lump self-storage projects in with other real-estate endeavors, McCune says the chance of getting favorable treatment is reduced. "With self-storage being kind of at the lowest rung of lending in the banks, they're likely to lend on self-storage projects when they've got a customer who builds shopping centers and things they're more likely to put their real-estate allocation toward."

Technology

The addition of even more technological enhancements is one trend that most agree will continue indefinitely. Though incorporation of the Internet into the self-storage industry has perhaps not been as rapid as first anticipated, its potential continues to develop.

"We keep talking about the Internet, but I haven't seen it make huge inroads just yet," Pogoda says. "We advertise and have our listings online, but our tenant base from the Internet is miniscule at this point--with the exception that it's a little bit larger for our locations near college campuses. So that would give you the indication that it's going to become bigger in the future.

"I can foresee a time when we can sign leases online because of the new act that was just passed by Congress allowing electronic signatures. I can see that being advantageous in the future, but it has not yet been revolutionary in this industry."

Some are more optimistic about the web. "The Internet is going to continue to play a vital role in this industry in selling your product to the marketplace," says Dave Cook of Tacoma, Wash.-based Tech-Fast Metal Systems. "It's going to be much more interactive as a part of e-business as opposed to simply a marketing tool. Convenience, speed and accessibility to information are going to help you stand out from your competitor. And that's what the industry has always been doing anyway--from building plain, rectangular boxes in an industrial site to an architecturally pleasing, multistory project in a residential zone, you're providing convenience and services closer to the needs of the consumer."

Other types of technology are also making an impact for Cook. "From the construction process side, we and others are pursuing technology as a means of providing a better-quality product to the marketplace faster," he says. "Speed is a huge motivator from a development perspective, because the obligations are in place, and another day that goes by is another day of rent you don't receive until you get open.

"We view technology as an absolute requirement to stay competitive and ahead of the market. We need to push on that because the timeline is being pulled from the other direction--zoning conditions, code requirements and the permitting process are getting longer. You need to be pushing the speed of what you have under your control, because the things out of your control are taking longer."

Management

Though owners of self-storage facilities may possess a world of knowledge and experience, it's widely believed an individual facility is only as successful as its on-site manager. However, for some self-storage operations, finding and keeping good management is a monumental struggle.

"Most of the really top-notch managers who have been around awhile are able to acquire the positions with companies that are offering higher pay, better benefits, etc.," says Holsinger of Executive Self-Storage. "The industry is still, in my opinion, lagging in terms of manager salaries and being able to compensate employees for what they actually accomplish. It's no longer just 'Let's hire an older couple that has a retirement income and let them be caretakers.' That age is gone. You need somebody who's aggressive in selling, intelligent in office procedures and has the common sense to help both the customer and the company."

Holsinger credits seminars offered by Inside Self-Storage, the Self Storage Association and others for helping to fill the training void. "There's still a large gap between trained and untrained managers, but I think that gap is slowly closing," he says. "The training is available, and I think now you're seeing a lot of people take advantage of it. I think our managers, overall, are much better than they were even three years ago."

Niche Markets

When the term "niche" is used in the context of self-storage, it can refer either to geography or market focus. Whatever the definition, "niche" is a word used with increasing frequency in the self-storage business.

"The self-storage industry has always been a niche business, and it's becoming even more of a niche business now," says Greenwald, using the geographical definition. "A number of years ago, I would hear owners say they were drawing their tenants from up to a five-mile radius; and then probably three or four years ago, we were looking more at a three-mile radius. But now, I've had a number of owner/operators tell me that they're drawing a majority of their tenants, when they're in a built-up area like Phoenix, Seattle or Portland, from within a two-mile niche."

Specialty-niche markets are also being pursued by self-storage operators. Legal documents, wine, fine art, antiques, classic automobiles and other items demand storage space, and in many cases it isn't feasible or cost-effective for owners of these items to maintain or create their own storage facilities. Converting facilities to house such items often makes sense for enterprising self-storage operators. To this end, Coast-To-Coast Storage has recently launched a store repositioning product, offering a combination technology/store improvement package along with market and management information.

"I think there's more awareness that we need to increase our product base in order to maintain the occupancies, and most of these kinds of things require some upgrading of our facilities," says Kliebenstein. "So it goes hand in hand with repositioning a store. You need to find new horizontal markets to go after, whether it be wine storage, antique storage or whatever. It is not my belief that the best way to compete with a state-of-the-art facility is to lower your prices--that just doesn't make sense. An investment in your assets will go a lot further than just lowering your prices. I think necessity has been the mother of invention here. As folks look for new ways to create storage opportunities, they become a little more industrious in going after new markets."

The Year Ahead

What the long-term future holds for the self-storage industry is only speculation at this point. Though many factors point toward a slowdown, most downplay it and some dismiss the notion entirely.

"Self-storage is a great investment in the long run," says Bancap's Keller. "It's stable, it's safe, it's got good returns that are fairly predictable, and I think that's why you see a lot of stability and a lot of good cash flow coming from the publicly traded REITs.

"It's going to continue to be a good market for owners and operators," he adds, "but be careful of new development. All it takes is one brand-new, empty facility across the street from you to really have a dramatic impact on your cash flow."

"I'm still very bullish on the future of the industry," says Chiswell. "It still represents, to me, one of the greatest entrepreneurial opportunities in America in terms of creating a small business that can generate the kind of revenue our facilities can, and the kind of financial return to that entrepreneur who is willing to venture forward."

A few are exercising caution, however. "Who knows what the stock market will be like going into 2001, but we sure appear to be in very precarious times," says Pogoda. "I think the combination of the potential downturn many of us have been expecting for years, and the tremendous increase in capacity ... well, it's just simple economics. Something has to give. At least in the markets I'm in, we appear to be at that point."

Finally, at least one insider is steadfastly convinced that anything can happen, and therefore sees speculation as pointless. "The longer I'm in this business, the more humble I'm getting," says Gay of Marcus & Millichap. "I can't even predict sometimes which of my own deals will command what kind of prices and which ones will close. So when I try to make forecasts of what's going to happen in the market in general, I'm on even thinner ice."