The Cup Runneth Over
Copyright 2014 by Virgo Publishing.
By: John R. Nikolich
Posted on: 11/07/2006



 

Real estate operators have an unparalleled chance to solidify equity capital for the next three to five years, thanks to the strength of the self-storage industry and availability of institutional capital. Establishing a joint venture with an institutional partner positions you to take advantage of compelling investment opportunities as they emerge.

After the 2000 stock market collapse, renewed interest in real estate accelerated capital flows into the sector. Institutional investors, flush with capital, are actively seeking attractive real estate investment opportunities. However, finding quality management teams to back projects is challenging. Successful self-storage companies with a convincing strategy, solid positioning and clear vision for growth have unprecedented leverage.

Well-positioned storage companies can make money “on the buy.” Conditions always change, so it’s likely we’ll soon see an abundance of investment opportunities but a dearth of capital as a result of some unforeseen event. Smart real estate companies secure capital when it’s affordable, strategically positioning themselves with “dry powder” should investment opportunities arise. Good news: There’s been no better time in the last 20 to 30 years to raise capital to fund real estate. Self-storage operators have a great opportunity to take advantage of market conditions and lock in reasonably priced long-term capital.

Joint Benefits

One of the biggest challenges for owners is deciding whether to secure a long-term equity commitment from an institutional partner rather than relying on their own equity or private capital network to fund projects on a deal-by-deal basis. A company may obtain attractive pricing and higher returns through an informal investor network, but will often generate significantly higher profits by establishing a joint venture.

Institutional partners are positioned to take advantage of capital opportunities as they arise. This allows self-storage owners to focus on adding value to the real estate side of the business, rather than being constantly preoccupied by financing. When researching joint ventures, look for an institution that offers:

  • Dependability
  • Chemistry among partners
  • Control
  • Good economics
  • Commitment
  • Strong sense of timing

Ultimately, a company must balance economics and control with a dependable and timely capital source.

Steady Wins the Race

Self-storage has gradually transitioned to a core-plus asset class over the last five years and is migrating to a core real estate asset class. The sector is no longer considered a land play because many office, industrial, retail and hotel assets have converted into self-storage. Storage is more appealing than alternative real estate investments because it captures the best attributes of the four core real estate asset classes (office, industrial, retail and multifamily) without their negatives.

Given the shorter development time frame for self-storage, market reaction is faster compared to other real estate sectors. Consequently, overbuilding is not as likely a problem and occupancy rates remain high through economic cycles. Even in early 2000, while many sectors experienced deteriorating operating results, self-storage maintained strong occupancies and operating results. The average industry occupancy was 84.8 percent in 1992, 85.1 percent in 1997, and 84.2 percent in 2004—well above the 60 percent to 65 percent breakeven number required to cover operating expenses and debt service.

Additionally, storage has provided steady returns relative to other sectors. Over the past five years, self-storage REITs have significantly outperformed the stock market as well as the overall REIT market. This is mostly because self-storage demand tends to remain relatively stable throughout various economic cycles. And storage properties tend to hold value better and recover faster from downward cycles due to their short-lease terms.

Shorter leases also enable operators to adjust rental rates on a daily basis to reflect market conditions. Furthermore, self-storage operations have a comparatively low level of bad debt and collection expense; in fact, they had the lowest CMBS default rates of all property types (0.57 percent compared to the average default rate of 2.4 percent). As a result of relative stability, high margins and the compelling investment returns, institutional demand for self-storage investments continues to remain strong.

Typically, real estate operating companies form joint ventures with institutional investors that commit $50 million to $400 million in funding an acquisition and development pipeline for the next three to five years. Over the past eight years, more than 25 institutional investments have settled into the self-storage sector. Are you ready to be the next beneficiary? 

John R. Nikolich is the managing director and founder of Flint Creek Partners, which provides financial advisory, venture capital and investment banking services to real estate firms and their investors. Headquartered in Chicago, its principals have more than 25 years of direct and institutional real estate investment banking experience and have raised more than $6 billion for clients, including approximately $1 billion in the self-storage sector. For more information, call 847.462.5927; visit www.flintcreekpartners.com


Self-Storage Wins High Marks

Institutional interest in the self-storage sector is extremely high because of its stability and other appealing attributes:

  • High operating margins 
  • Diversified tenant base 
  • Operator pricing power in regard to rental rates 
  • Short development cycle (less susceptible to interest rate risk, political changes or dramatic shifts in supply or demand) 
  • Higher returns relative to core real estate investments 
  • Relatively low construction cost per square foot and a straightforward construction process, although zoning and entitlement can be challenging 
  • Low cost of tenant turnover and improvement requirements