IT IS NOT OFTEN SOMEONE IN THE REAL ESTATE BUSINESS WILL OFFER A GUARANTEED PREDICTION OF THE MARKET, but here it is: It will be different from 2002! I realize this doesn't seem like much help in planning for the future, but if you spend 10 minutes reading the balance of this article, you will find the prediction to be more helpful than you might have thought at first glance.
Since you now have a guarantee things will be different in the real estate market in the new year, let's look at what the last months of 2002 were like and divine some insight into specific distinctions. In general, 2002 was a great year for self-storage owners and buyers. There was an unusual confluence of economic factors that created this very positive circumstance. Let's take a look at what some of these economic forces were and explore the possibility of them continuing this year.
In 2002, the real estate market saw its lowest interest rates in 40 years. It is almost impossible to overstate the positive impact low rates have on real estate. With rates where they are, the cash-on-cash returns on self-storage deals are up by 50 percent or more in some cases. Clearly, this situation is good for potential buyers as well as sellers. The sellers have more cash flow after debt service, which is what buyers ultimately are purchasing.
The question, of course, is what happens this year? The Federal Reserve (Fed) has indicated it will not raise interest rates, but on the other hand, it has not lowered them recently either. Even if the Fed lowered rates again, it isn't clear rates for self-storage loans would go down much because most of the lenders would not make loans at lower rates. A reasonable conclusion is--given 40 years of history--rates are probably more likely to go up than down; and if they go down, they won't go down much.
In 2002, banks and other lenders were eager to get money out and make loans. Real estate was a favorite, including self-storage. At the end of the year, we were beginning to see lenders becoming more cautious about lending on real estate in general. Other forms of real estate have not performed as well as self-storage, causing lenders to become more critical in their evaluation of real estate loans. Office buildings have been very soft, retail is overbuilt, apartment vacancies are up dramatically, hotel occupancies are lower--all of this causing lenders to become more wary.
While I would, of course, argue self- storage is different, lenders will say they have heard this before and continue to lump real estate all together. When the senior bank officers say to curtail real estate loans, they won't add the caveat "except for self-storage." In the Oct. 26 issue of The Economist magazine, the head of syndicated loans at a large American bank said, "Two months ago, I would have said the chances of a credit crunch were too small to measure. Now, they are better than even."
Another problem for self-storage loans is they are usually small by real estate standards, and most lenders are somewhat reluctant to fuss with them if they have a good, larger alternative. Since liquidity was not a problem at all in 2002, any change in liquidity is going to be negative in the new year. This is a very important issue because, while low interest rates make deals work well, liquidity (loans) makes them possible.
The general economy was thought to be in a recession during a couple of quarters in 2002. However, most self-storage properties seemed to fare reasonably well for at least the first part of the year, although there are reports of higher vacancies in recent months. We are encouraged because government economists continue to tell us the recession is over and recovery is well on the way. However, as I write this, The Wall Street Journal reports consumer confidence is at a nine-year low. It appears the future isn't very clear, and for now, neither boom nor recession is ruled out by the data at hand. Until the base economic direction becomes clear, it is likely the real estate market will react negatively to this uncertainty in the early part of 2003.
The rental market for self-storage has been strong enough to encourage development in many areas, pushing some markets into an overbuilt situation. The attractive elements of self-storage in 2002 made developers a bit overzealous in their development programs. Chasing the apparent high returns may not have killed the Golden Goose, but certainly, some shot was put in the air.
For example, one southern market has 13 facilities in a seven-mile radius, with 11 more under construction. This year will certainly be different from last for those properties competing in that market. Several other markets are reported to have many new facilities coming on board. The national statistics do not yet forecast a general problem, but anecdotal information indicates overbuilding is occurring in many local markets and is likely to impact many more over the coming year.
What Should You Do?
Most self-storage owners do not sell their properties because of a downturn in the market, but for personal reasons such as retirement. This is a good long-term approach if your property is well-located and competitive. If these basic elements are in place, it's hard to find a better investment for the long run than self-storage.
However, if you are planning to sell in the near term (i.e., the next two or three years), or your property is not competitive in the current or forthcoming marketplace, it may be time to sell. The market remains strong for sellers, and there are many people discouraged with the stock market who think self-storage would be a great investment--and it will be. But if too many things change in 2003, the industry may transform dramatically. If you think about how unusual recent years have been and the potential changes that could take place, the time for action may be now.
By the way, if you plan to hold your property for a few more years and haven't done so already, consider refinancing. The rates available are truly once-in-a-lifetime deals. One of the great things about lower rates is they also reduce your breakeven point, which reduces your exposure to any downturns in the economy.
Michael L. McCune has been actively involved in commerical 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 January 1994, he created the Argus Self Storage Real Estate Network, now the nation's largest network of independent commercial real estate brokers dedicated to the buying and selling of self-storage facilities. For more information, call 800.55.STORE or visit www.selfstorage.com.