Self-Storage Facilities Gain New Respect

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Self-Storage Facilities Gain New Respect

By Aziz Khan

Six short years ago, many owners of self-storage facilities felt like the Rodney Dangerfields of commercial real estate. Stigmatized as owners of the physically unattractive, sub-investment-grade developments no one wanted next door, they were in search of greater respect, both from the surrounding communities who enacted tough zoning laws to limit new development and from lenders and investors who gravitated toward more glamorous property types.

Fast-forward to 1999, however, and these owners face improved prospects. Consumer demand for self-storage space is still growing steadily in many markets. What's more, the tremendous influx of investment capital to the commercial real-estate market has created a buyer's market for fixed-rate loans as low as 7 percent to 8 percent. Though most lenders still favor owners and investors seeking to refinance existing debt or finance new acquisitions, loans for new construction are becoming easier to obtain as a more diverse, better informed group of lending institutions casts its eye on the self-storage market. From the local banks and savings and loans that kept the industry afloat during more turbulent times to today's portfolio investors, conduits and private capital-investment funds, lenders are finally awakening to the tremendous upside this market can offer.

These favorable conditions give veteran owners several powerful options. They can refinance their current debt and lock in a fixed-rate loan, a strategy that enables them to draw out a significant amount of equity, reduce debt costs and increase bottom-line cash flow. Alternatively, those seeking an exit strategy can take advantage of the voracious appetites REITs currently have for established, well-performing properties. With low interest rates and cap rates on their way down, properties are selling quickly at prices current owners never imagined possible. Owners can maximize their selling price by working with an experienced broker who understands how to package self-storage properties to both REITs and individual investors.

Steady Transformation

Just how attractive has the self-storage market become to lenders? The industry has admittedly attracted fewer lenders than other commercial properties because many still view these facilities as higher-risk operations. Further, many balk at the management-intensive nature of this business, citing high turnover rates and collection dynamics reminiscent of the hotel industry. For example, the average rental period for residential self-storage customers, who represent 76 percent of business volume, is just 10 months--21.3 months for commercial customers, according to the 1997-1998 Self-Storage Almanac. The same source lists the 1997 average occupancy rate for the 26,272 facilities nationwide at 85.12 percent.

Lenders with experience in this market, however, see a different picture. They focus their attention on established facilities with proven track records, experienced management and higher local profiles because they boast occupancy rates closer to 90 percent. Experienced lenders also note that the average cap rate of 10.64 percent, based on data compiled by the 1997-1998 Self-Storage Almanac for 172 selected facilities nationwide, declined from the 10.77 percent reported a year earlier. Their conclusion is obvious: Providing capital for refinancing and acquisition is not as risky as some investment professionals think.

Powerful Change Agents

Irrespective of its position today, though, the self-storage industry can anticipate a bright future because it will benefit from a combination of favorable market and demographic forces, significant product changes and the industry consolidation that will continue as long as REITs compete furiously to acquire new properties.

The aging of the baby-boom generation and shifting population trends are fueling demand for self-storage facilities. The growing seniors population points to increased storage demand as they downsize to smaller residences and migrate to lifestyle-driven destinations such as Florida, Arizona and California. Furthermore, shifting migration trends will continue to create new pockets of demand as new residents flock to popular sunbelt locations and chase the stable employment opportunities found in the rust belt markets. In Tempe, Ariz., for example, Heller Real Estate Finance recently provided a first-mortgage loan to refinance a Class "A" facility that was constructed in 1995. Though an additional self-storage facility is scheduled for development in the vicinity, demand in the area is likely to grow much faster than supply. During 1996, 1,600 new multifamily housing units were developed within a two- to four-mile radius of the property, and another 2,000 units came on-line in 1997. A number of single-family housing subdivisions are also under development, most lacking the built-in storage space that basements or full garages provide.

The self-storage industry is also strengthening its appeal by introducing new products that respond to evolving consumer demand. Today's new facilities offer a broader choice of rental dimensions and amenities, such as computerized accounting and security systems, climate control, and computerized lighting and utilities that help hold down operating costs and rental rates. A case in point is a facility Heller recently refinanced in Phoenix, which offers a comprehensive security system that includes video surveillance, climate control and spaces for boats and RVs.

The third significant trend, consolidation, may cause some growing pains over the short term, but promises to further stabilize and solidify the market over the long term. Short-term consolidation of ownership has brought with it a flurry of new construction as well-capitalized companies jockey for position, and occupancy rates may suffer in certain markets as the 400 new facilities currently under construction come online. In the long term, however, consolidation will drive up total quality. When REITs first targeted the self-storage markets in the early 1990s, few facilities qualified as investment-grade properties. In today's consolidated landscape, almost half of the self-storage properties nationwide meet this standard. In effect, REITs have not only established higher levels of valuation, they have ushered in a new competitive standard for both professional facility management and for marketing as well. Independent self-storage facilities, for example, have begun to form marketing co-ops that allow them to purchase the large quantities of advertising space they need to increase name recognition.

A New Level of Respect

In the self-storage arena, the presence of conduits and the growing number of lenders who understand this market have lessened--but not eliminated--the struggles owners face to secure financing, especially if they seek construction loans. But as REITs continue to work their magic--driving up values and driving down cap rates--and as the real-estate community becomes more attuned to the solid underlying fundamentals this property type offers, owners and investors may see signs of even greater respect and a more favorable financing environment in the years ahead.

Aziz Khan, director of capital markets at Heller Real Estate Finance, is product manager for the manufactured-home and self-storage markets. As a national lender to those markets, Heller offers a broad range of debt and equity-loan products, including fixed-rate conduit loans, through its Heller Express Program. Mr. Khan can be reached at (312) 441-7945.

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