Financial-Crisis Survival Guide for Self-Storage Owners
Copyright 2014 by Virgo Publishing.
By: H. Michael Schwartz
Posted on: 03/30/2009



 

As the economy continues to struggle, even top economists are unable to say definitively when we’ll see an upturn in the market. This uncertainty has frozen the real estate markets, making acquisition a challenging process during the past year and for the foreseeable future.

Complicating things further, we don’t know how and when the government bailout dollars will reach the market and what it will take to shake that money out of financial institutions.

But on the bright side, transactions are still getting done, especially in the self-storage market. We are seeing opportunities in the marketplace for skilled but cautious investors willing to dig deep and recognize opportunity.
 
Debt vs. Equity: Has the Money Pipeline Opened?

As of the first quarter of 2009, debt remains extremely difficult to obtain, and if investors can obtain it, the terms are often less than favorable. We’ve seen lenders who have changed rates at the 11th hour and sellers who have balked at closing.

It’s clear that buyers and sellers need to be more creative by including the assumption of existing loans and seller financing as part of the discussion. Those kinds of things weren’t even contemplated in the sellers’ market of recent years.

As part of the equation, it’s more important than ever to be sure of the conditions on assumable loans. Be especially cautious of commercial mortgage-backed securities (CMBS), special servicers who attempt to change the terms of the original loan, as they scramble for better guarantees or improved creditworthiness of their borrowers. A loan purported to be assumable may not, in reality, be given this tactic.

Additionally, there will be a continued migration from single-property ownership to greater representation by the regional players and national real estate investment trusts (REITs). That said, from an equity standpoint, we are finding investors who are extremely interested in the self-storage market—particularly on the income side of this asset class.   

The story is simple. It’s easy for investors to understand this real estate sector. Self-storage is driven by people in transition: birth/inheritance, marriage/divorce, retirement, military enlistment, job relocation, business expansion and contraction. We see self-storage facilities throughout our neighborhoods. Many of us have at one time or another rented a self-storage unit.

Today, we’re seeing a steady flow of equity into self-storage and, in this economic turmoil, cash is king. To be successful in this challenging market, the investor needs to find a property that is priced right, with or without debt in the transaction. Being flexible is one of the keys to surviving the financial crisis. If an investor doesn’t have this flexibility, fewer options are available.
 
Investment Opportunities

Some economists predict the commercial real estate market is teetering on the edge of an imminent fall. According to the Urban Land Institute’s “Emerging Trends” report, “The credit crisis and ensuing recession promise to drag commercial real estate markets into a difficult period marked by value losses, rising foreclosures and reduced property revenues.

In 2009, expected total real estate private-equity investment returns will likely register in negative territory for the first time in nearly two decades. After an unprecedented meltdown, housing values should finally hit bottom during the year, followed by later corrections in the commercial sectors.” 

Looking at the performance of publicly traded REITs, as reported by the National Association of Real Estate Investment Trusts, we see a more defined story. While REITs as a whole were down nearly 38 percent in 2008, those specializing in self-storage were up 5 percent, the only property sector to post positive returns. That’s a full 43 points above the average. The next closest sector was healthcare, down 12 percent.

Of course, REITs are traded, which means they’re more affected by the equity markets than the underlying value of the real estate, and cannot be compared to privately owned real estate. But the relative sector performance speaks volumes.

So what does that mean to self-storage? Indeed, many owners are simply watching and waiting, holding onto their cash-flowing properties until the market shifts. On the other hand, some investors are seeking opportunities, analyzing key markets with strong demographics. In addition, we’re seeing signs of distressed properties that will offer prime buying opportunities in the next 12 to 18 months. 
 
An Oasis in a Recession?

Clearly, the financial markets are undergoing a great deal of strain given the over-leveraging that has occurred over the last few years. This de-leveraging process has caused many financial institutions significant pain. If we take a look at our economy, there are only a few areas not directly affected by the downturn in the market.

Developers, builders, homeowners, commercial property owners, hedge funds and private equity are all taking a hit. Unfortunately, it might take a long time before we truly hit bottom. There are few glimmers of a recovery right now.

The good news is the self-storage market offers recession-resistant traits. There are a few signs of weakness in some markets but, overall, the sector is performing well. While no industry is immune to a down economy, this asset class is quite stable.

According to the National Bureau of Economic Research (NBER), specific start and end dates for each recession are determined by the gross domestic product (GDP), employment, industrial production, retail sales and other factors. NBER states these determinations are often made more than a year after the fact; however, a commonly used alternative definition of a recession is two consecutive quarters of shrinking GDP. Some forecasters say we have been in a recession for a year already and the GDP growth will return, albeit slowly, by the end of this year. 
 
Refinance?

Deciding to refinance depends solely on the value of the real estate property. If the property was acquired a few years ago, it would be difficult to refinance, as the terms could be much different. Also, the value of the property may have declined. If this is the case, the owner may have to increase his equity.

Currently, we’re experiencing a circular challenge in the lending community. It’s clear that our government is placing pressure on lenders to lend, but the terms presented are ones investors are unwilling to accept, thus lending is at a standstill. This will hopefully improve over the next 24 months. 
 
Commercial Real Estate in the Cold?

It looks as if commercial real estate executives need to face the realization that federal dollars will not be used to clear debt off lenders’ balance sheets. The Troubled Asset Relief Program (TARP), a measure many believed would open the clogged financing floodgates, was suddenly snatched away this past November. Treasury Secretary Henry Paulson declared that purchasing illiquid mortgage-related assets “is not the most effective way to use TARP funds.”

But there’s still a sliver of hope that the Treasury will help troubled commercial real estate debt. The injection of TARP funds would start to create the stability we need, but it would also cause issues such as an excessive budget deficit and going from deflation to inflation. 
 
What Lies Ahead

In the first half of 2009, further deterioration in real estate fundamentals will force many investors who are still clinging to unrealistic asking prices to swallow a bitter dose of value correction. At the same time, buyers will have to settle for annual returns based on existing income streams rather than the skyrocketing price appreciation that made commercial real estate golden earlier in the decade.

The best way to survive the credit crunch is to not rely on debt. If investors need debt to close a transaction, they should use cash of at least 50 percent of the acquisition price. The lesson we’ve learned has been as simple as it is painful: Leverage is good, but only in moderation. 
 
H. Michael Schwartz is the chairman and CEO of Strategic Storage Trust Inc., a publicly registered, non-traded REIT with a portfolio that includes more than 1,800 storage units and 196,000 rentable square feet. The company’s sponsor is U.S. Commercial LLC, which manages a growing portfolio of 5 million square feet of commercial properties, including 2.9 million square feet of self-storage. For more information, visit www.strategicstoragetrust.com.

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