Overbuilding
Copyright 2014 by Virgo Publishing.
By: Michael L. McCune
Posted on: 07/10/2006



 

Overbuilding in self-storage doesn’t always get the attention it deserves. Owners need to focus on why it occurs, the repercussions, and how to avoid overbuilding in local markets.

Overbuilding is a market condition in which self-storage supply exceeds demand at any given time. Using this definition, almost all markets are overbuilt to some degree if more than a nominal vacancy exists. For example, a stabilized market averaging 88 percent occupancy could mean it’s overbuilt by 12 percent. While such an occupancy rate may not be economically life threatening, it does indicate demand is being met.

Demand

Unfortunately, we know little about demand. The Self Storage Association (SSA) is trying to quantify and predict demand, but the task is complex and results are inconclusive. For 30 years, no one has worried about demand because there has always been so much pent-up need for self-storage.

This era is likely to draw to a close, according to Ray Wilson of Charles R. Wilson & Associates. In 2003, Wilson studied a large national portfolio and concluded the number of households in the market averaged only 4.8 for each storage unit (markets varied between 3 and 7.7).

One study also revealed 40 percent of demand comes from the facility’s own ZIP code, 20 percent from the adjacent two ZIP codes, and virtually all demand within four miles. We also know population and household incomes influence demand, but we are not sure why. Thus, we can be reasonably certain if demand is to increase, the market needs more people—hopefully affluent ones.

Supply

Self-storage supply is usually driven more by the availability of cheap money than a careful analysis of demand. Clearly, funds are plentiful for credit-worthy builders armed with a positive feasibility study. Our research indicates new builders, however, are less likely to conduct adequate feasibility studies and most likely won’t bring renters to a project. Their projects typically cost more, but their expectations are also higher. Another interesting tidbit about supply: 86.7 percent of existing facilities compete with three or more facilities and nearly 60 percent compete with six or more in their markets, according to the SSA.

Impact on Occupancies

Table I shows the impact of one new facility on a hypothetical typical market with an 88 percent occupancy level. Study it closely: Over time, existing occupancy will roll over and general occupancy will level out among the competitors, depending on their merits. If a new facility has a “better mouse trap” with more marketing, lower rents and other bells and whistles, they might actually get more (maybe a lot more) market share. Remember, a new competitor doesn’t create demand; he only steals it from someone else! As shown in Table I, a single project can drop the market’s average demand from 88 percent to 70 percent, incurring serious economic hardship on all parties if new demand doesn’t quickly sprout.

Cash Flow

An example illustrating the economic impact of “spreading” demand is shown in a hypothetical project in Table II. These numbers assume rental rates don’t decline as occupancies fall. However, a drop in tenants could easily cause gross rent receipts to fall by another 5 percent to 10 percent. The numbers indicate overbuilding can dramatically affect cash flow and value. Just one new facility can impact a market that fails to grow.

Assuming pent-up demand is nearly exhausted—as a stabilized 88 percent occupancy indicates—how long would it take to outgrow the problem of one new facility? In our example, with unlimited opportunities for growth and no new competitors, demand has to grow by 25.1 percent to recover 88 percent occupancy. The average American city has annual population growths of 1.3 percent, so it could take 16.6 years for the market to return to 88 percent occupancy, or seven years as the absolute best-case scenario.

If we use Wilson’s average of approximately five households per storage unit, an average household of 2.6 people and 100 square feet per unit, we would need to rent 528 units to new customers to return to 88 percent occupancy. This means 2,640 new households must come to our market!

Many areas are largely built out and unlikely to ever grow that much. According to expert planners, each household in a suburban metropolitan area uses about .75 acres. Therefore, to grow by 2,640 households, the target market area would need approximately 2,000 acres available for development!

Our rough calculations should only be used to understand the magnitude of overbuilding consequences. Even with major adjustments, the problem can be serious and impact owners significantly. Overbuilding doesn’t have to be a citywide or national phenomenon, but it can affect one small market. Only a careful analysis can pinpoint areas of overbuilding.

Michael L. McCune has been actively involved in commercial real estate throughout the United States for more than 20 years. Since 1984, he has been owner and president of Argus Real Estate Inc., a real estate consulting, brokerage and development company based in Denver. In 1994, he created the Argus Self Storage Real Estate Network, now the nation’s largest network of independent commercial real estate brokers dedicated to buying and selling self-storage facilities. For more information, call 800.55.STORE; visit www.selfstorage.com.