The self-storage industry has undergone a tremendous transformation over the past two decades. In its infancy, developers could build a facility at just about any location and reach stabilization in a relatively short period of time. However, as land prices continue to escalate and zoning restrictions become more stringent, site selection has become paramount in constructing successful facilities.
While a number of markets have become saturated due to high construction levels over the past several years, there are still many locations that are underserved, particularly in secondary and tertiary markets. New development is expected to continue to decline over the next year, which should help stabilize occupancies and strengthen asking rents. Sales activity will benefit as investors seek higher returns than those offered by mainstream real estate products with minimal management requirements.
Self-Storage Goes Mainstream
The acquisition of Storage USA by General Electric has lifted the self-storage industry into the big leagues. For years, the industry was dominated by mom-and-pop operations; however, the entrance of GE is certain to take the industry to a new level. Currently, only 11 percent of the industry is controlled by the top five largest self-storage companies, leaving nearly 32,000 facilities under the control of private ownership. Slightly more than two decades old, the self-storage industry is sure to undergo many more transformations.
Historically, self-storage facilities have been financed by local banks; however, the popularity of these facilities will continue to attract new sources of financing. Consolidation of the industry will continue to gain favor as competition increases. Although new construction of self-storage facilities is expected to continue to decline due to lower occupancies, a lack of affordable land and more stringent zoning restrictions, larger, well-financed companies will be able to capitalize on the segregated industry.
One example is the new emphasis placed on customer service. Customers are demanding a wider array of services, such as rental vehicles, 24-hour service and high-tech security systems. Larger, better-financed companies that are able to provide these services in a consistent, high-quality manner often achieve a competitive advantage over their smaller counterparts, resulting in higher values when the former properties are sold.
The West will once again set the bar for sales activity in 2003. This region led the nation during 2002 with nearly 45 percent of all self-storage construction, totaling approximately 6.2 million square feet. The lion's share of the new construction was concentrated in California, where more than 4.6 million square feet was completed. Despite the elevated level of construction, strong in-migration and a transient population kept occupancy levels stable at 88 percent.
Although it is difficult to compare rental rates among properties due to the large discrepancies in unit size, unit mix and services rendered, rental rates realized an increase across the board. (Note: For the purposes of this report, only three unit sizes were analyzed: 5-by-5s, 10-by-10s and 10-by-20s.) Rents grew at an impressive rate of 10 percent for 5-by-5 units, to an overall average of $35 per unit. However, rent growth would be considerably less if rental concessions, which are often offered on the smaller, more abundant units, are included.
As land prices continue to escalate, many developers have been inclined to add smaller units to the mix due to their higher rent per square foot, which makes the facilities more attractive to investors on a pro forma basis. Average rents realized an increase of 8 percent for 10-by-10 units, to $72 per unit. However, rents for the larger 10-by-20 units grew at a rate of only 3 percent, to $109 per unit.
The escalation in rents and a larger pool of real estate investors in the market helped push the median sales price per square foot up nearly 9 percent, to $57. The price per square foot has been skewed upward, however, due to a large percentage of sales occurring in California, which boasts a median price of $65 per square foot.
Declining construction levels will allow occupancy to rebound in 2003, but it will remain under the national average. In 2002, developers kept construction levels on par with 2001, bringing approximately 2 million square feet to the area.
Texas led the region, with almost 1.5 million square feet completed. Occupancy levels also remained constant at 84 percent during 2002; however, occupancies fluctuated greatly depending on the time of year and the state. For instance, 2002 numbers dropped to 81 percent occupancy, but then rebounded in the third quarter to 86 percent. Alabama had the lowest occupancy in the region and the nation, at 74 percent, while Louisiana had the region's highest occupancy, at slightly more than 88 percent.
Although rents remained flat at $26 per month for 5-by-5 units, average rents jumped 9 percent for a 10-by-10, to $52 per month, and 7.5 percent for 10-by-20s, to $77 per month. This increase appears aggressive at first glance considering the stagnant occupancy levels; however, much of the gain can be attributed to higher demand and a smaller supply of larger unit sizes.
Median sales prices slid more than 15 percent in 2002, to $29 per square foot. The decrease is attributed to a higher proportion of older facilities, which traded at an average price of $1.5 million, down from $2.2 million in 2001. However, investors continue to show strong interest in self-storage facilities due to their high cap rates, which are hovering around 10.5 percent, and the relatively small amount of upfront capital required to begin investing. A lack of for-sale inventory continues to limit investment activity due to the large percentage of owner/operators who view their properties as long-term investments.
Values in the Southeast are expected to increase in 2003 as occupancies continue to improve and positive rent growth materializes. Nearly 3.9 million square feet of storage space was brought to the market during 2002, down from 4.8 million square feet in 2001. Florida was surpassed by only California for the most self-storage construction in the nation, with nearly 2.5 million square feet completed in 2002.
The large amount of new construction has lengthened rent-up schedules; only 17 percent of facilities reach 70 percent occupancy during the first six months of operation, compared to the national average of 29 percent. Although occupancy levels improved by nearly 200 basis points during 2002, average occupancy in the region, at 83 percent, remained nearly 250 basis points under the national average.
Average rents for 5-by-5 units increased by a moderate 2.5 percent, to $32 per unit. Relatively low occupancy levels also kept average rents for 10-by-10 units stable, at $60 per unit. However, 10-by-20 unit rents actually declined 1.5 percent during 2002, to $92 per unit.
Low occupancy levels and stagnant rent growth translated into a reduction in sales prices and rising capitalization rates. The median sales price fell more than 10 percent, to $42 per square foot. Meanwhile, cap rates increased 100 basis points, to an average of 11.3 percent, to offset the increased risk associated with these investments.
Inclement weather has translated into increased expenses for operating and maintaining facilities in the region. Damage from an unusually severe storm season caused insurance claims--and later, premiums--to spike. Maintenance expenses also rose as owners swallowed deductibles and funded repairs themselves in an attempt to reduce premium hikes.
An abundance of affordable financing and high barriers to entry will translate into buyers paying premium prices for well-located facilities in the Northeast. The scarcity of affordable land surrounding highly populated areas has kept development under control.
Construction declined by nearly 400,000 square feet during 2002, to 1.45 million square feet. States like New York and Massachusetts have an average of 1.6 and 2.4 square feet per resident, respectively, compared to the national average of 4.3 square feet. Furthermore, many of the swelling units in these large metropolises often have very little storage space, creating a greater demand for off-site storage. As a result, the Northeast region boasts the highest occupancy level in the nation. High demand and limited supply have kept average occupancy elevated, at 88 percent.
Relatively high occupancy rates allowed owners to raise rents considerably in 2002, particularly for larger, more popular unit sizes. Rents grew at a moderate 4 percent for 5-by-5 units, to $35.50 per month. However, 10-by-10s and 10-by-20s realized dramatic increases of 31 percent and 36 percent, to $93 per month and $145 per month, respectively.
Rents in this region have historically been the highest in the nation. Much of this is attributed to the many climate- controlled facilities in these densely populated areas. In response to skyrocketing rent growth, the median sales price increased by 35 percent, to $55 per square foot. With an average-sized transaction at 76,000 square feet, the Northeast region boasts the highest average price per transaction, at nearly $4.7 million.
A limited amount of new supply will boost occupancy levels and rent growth in 2003. Construction fell dramatically during 2002, with the completion of only 600,000 square feet of storage space, compared to 1.3 million square feet in 2001. Nearly half, or 270,000 square feet, was built in Illinois, which led the region for the second straight year. Despite higher levels of construction, however, Illinois continued to lead the region in occupancy, recording a healthy 92 percent, which is 7 percentage points above the region's average of 85 percent.
On the whole, occupancy in the region slipped 300 basis points during 2002. There are, however, large fluctuations in renter demand depending on the season, which pushed average occupancy from a low of 78 percent in the winter to a high of 88 percent during the summer.
In spite of faltering occupancy growth, rents managed to grow at a healthy pace. The average rent for a 5-by-5 unit increased by 12 percent during 2002, to $30 per unit; however, it remains below the national average of $32.50 per unit. The average rent for 10-by10s grew at about half that rate, to $54.50 per unit. Likewise, remuneration for a 10-by-20 grew at a similar rate of 6 percent, to an average of $80 per unit--again, well below the national average of $98 per unit.
Investment activity slowed slightly during 2002, as many owners elected to hold on to their properties during the uncertain economic conditions, which contributed to the 25 percent increase in the median sales price, to $58 per square foot. Meanwhile, average cap rates remained steady at levels between 10 percent and 10.5 percent.