The Phoenix real-estate market is in its sixth year of a flourishing self-storage boom. The most elusive element with any cycle is knowing when it has reached its peak and the slide downward has begun. With more than 200 people per day moving to the Valley, storage demand soars. The number-one threat to real estate has always been oversupply, which puts downward pressure on rental rates, occupancy and net-operating income. Investors then begin applying higher cap rates, resulting in lower values for your facility.
So, where are we in the latest self-storage cycle? There have been three major decades in the history of the Phoenix self-storage industry. The '70s, '80s and '90s were each a distinct period. It's important to review the history of each to understand where we are headed.
In the Beginning...
The birth of self-storage in Phoenix began in 1970 and continued for a decade. Averaging annual additions of 400,000 square feet, while reaching 2.6 square feet per person, a healthy industry developed.
The 1980s: Boom and Bust
The 1980s boom began in 1982 with the abundant flow of syndication capital. The rumble of self-storage construction was heard throughout the Valley as 6.7 million square feet (more than one million square feet per year) was added to the base. An incredible all-time record was established in 1985 with the erection of 37 facilities totaling more than two million square feet. The '80s topped out in 1987 with an all-time record supply of 5.38 square feet per person. The bust hit in 1988 with the Savings-and-Loan failure and the lack of available capital. The bust lasted for nearly seven years and yielded almost no construction.
The Roaring '90s
The roaring '90s came alive in 1994 with the revival of construction. There was pent-up demand in many parts of the Valley. Interestingly, more than 50 percent of the new construction in 1994-1995 was by first-time self-storage developers. In fact, during the '90s, there have been 27 facilities opened by developers new to the industry. Construction continued to grow throughout the decade with annual construction nearing one million square feet since 1996.
So where does 1999 fall in the cycle and where will the new millennium take us? Six new properties have opened in 1999, and 12 more are under construction. More alarming are the 21 that broke ground in the second half of the year and another 46 proposed for the future. More than one million square feet of storage was added during 1999. Despite all of the fears associated with overbuilding, the current overall occupancy rate remains near 80 percent.
The unprecedented growth in new residential construction and the increase in population is driving the current cycle of self-storage construction. Population increases of 80,000 per year create an absorption level of 320,000 to 400,000 square feet. So why are we adding one million square feet annually, and will this create an overbuilt situation?
It seems that the self-storage industry is increasingly viewed as a niche business. We must, therefore, look at the submarkets rather than the overall market. Developers and operators have replaced their three- to five-mile competitive analysis and are focusing more frequently on a two- to three-mile competitive radius. Successful developers are employing more sophisticated tools in their site selection. Global positioning, system-based demographics and competitive analysis are now common. On the surface, it seems that self-storage has been overbuilt. However, some of our older space is functionally obsolete and is being replaced by state-of-the-art product. The new product offers features such as climate control and advanced security features.
It appears that the real-estate axiom of "location, location, location" is in full gear in the Phoenix market. An audit of successful new stores finds high absorption rates for well-selected sites with lagging leaseup in poorly positioned properties. One store filled completely in five months with another currently leasing three per day. On the other hand, there are stores that have been open for two years that are having real difficulty reaching their lease-up projections. Competing objectives present a challenge for the independent developer. While the independent developer seeks a site based upon an initial desired return, the national REITs sometimes are driven by the desire to increase market share.
As we enter the new millennium, only one thing is certain: The self-storage industry will be shaped by its developers and owners. Development planned solely for the "high returns offered by self-storage" must give way to responsible development in demand-driven niches. Development returns on new properties, as well as the value of existing facilities, are sure to decline from the high levels of the recent past unless sound fundamentals replace speculative overbuilding. Let's hope for the pursuit of responsible development, which remains well focused and selective.
Kent Greenwald is a first vice president of CB Richard Ellis Self Storage Advisors, which has participated in the sale of more than $350 million worth of self-storage properties. Mr. Greenwald may be reached at (602) 735-5519.