As we begin the new year, our roundtable of real estate experts discusses the national self-storage market. Lets hear what they have to say about their respective cities and regions. Joining us in our survey this month are: C. William Barnhill, Omega Properties, Mobile, Ala.; Clifford Crowe, Lee & Associates, Carlsbad, Calif.; Dale Eisenman, Midcoast Properties Inc., Hilton Head Island, S.C.; Larry Hayes, Larry Hayes & Associates, Missoula, Mont.; Richard Minker, Richard D. Minker Co., Fort Worth, Texas; and Joseph Mendola, The Norwood Group, Bedford, N.H. I will also contribute some comments on the national marketplace.

DESCRIBE HOW YOU SEE THE RECENT CAP-RATE TRENDS IN THE SELF-STORAGE INDUSTRY. DO YOU SEE CAP RATES CONTINUING TO MOVE UP? HOW FAR DO YOU THINK THEY WILL GO?

Barnhill: It is obvious cap rates have been trending downward due to combined pressure of property demand and low interest rates. Because cap and interest rates are sensitive, it is unlikely cap rates will vary substantially until interest rates significantly rise. The status of the economic recovery will ultimately be what drives the increase in cap rates. It is unlikely we will see them exceed the 10 to 10.5 range in the immediate future.

Crowe: There is a big rush of investors in California trying to move the equities from other property types that have lower yields (for example, apartments in the 6 percent cap range) to storage properties. Where the cap rates were 9 percent to 9.5 percent last year, they are now nearly one point lower due to high demand. The storageproperty owners are holding, creating a further move to find development sites. These, too, are in short supply. With the huge move, in due time, the pendulum will eventually tilt to over supply, but not today.

Eisenman: I think they are fairly stable. No, I dont think they are moving up.

Hayes: Cap rates are moving down or stabilizing, not going up. As interest rates increase, there should be a corresponding upward movement of cap rates. Unfortunately, there will probably be a lag, creating a time when buyers will refuse to purchase until the upward adjustment is real.

Mendola: Cap rates should remain relatively low, in the 9.5 percent range, for properties that are not in the all-cash category. As long as investors can achieve a 10 percent cash-on-cash return going in and the mortgage constant is under 10 percent, sellers and buyers should benefit from this positive interest-rate market.

Minker: We are finding the use of cap rates as a guide, since each buyer makes his own adjustments and has his own interpretation of the net operating income (NOI) to which to apply his cap rate. Therefore, while one investor may arguably be paying a 9.5 percent cap, another could only be paying a 10 percent cap at the same price because the NOI is different. With that said, we are seeing better quality properties selling at a sub-10 cap rate, while older properties are in the 10.5 to 11.5 percent range.

As others have noted, these are truly remarkable and historic times in self-storage for cap ratesremarkable, but are they sustainable?

IS THERE MORE OR LESS 1031 MONEY IN THE MARKETPLACE? THERE SEEMS TO BE QUITE A BIT. DO YOU SEE THIS CHANGING? IF SO, WHY?

Barnhill: Although the capital-gains tax rate has been lowered to 15 percent, investors still are inclined to defer whatever tax they can with 1031 exchanges. Some, however, elect to pay the tax and reinvest. There is a substantial benefit to starting with a new tax basis, due to the benefits available through cost segregation and the 50 percent bonus depreciation available to new property with a depreciable life shorter than 20 years.

Crowe: In California, there is an abundance of 1031 money waiting for replacement property.

Eisenman: Possibly, as interest rates rise, there may be fewer sellers of other product types, generating less exchange money. Also, if alternative investments look attractive (securities, other real estate product types), they may move money away from self-storage.

Hayes: There has been a glut of 1031 money in relation to available properties for reinvestment. Many people are making the decision not to sell because they are concerned about finding replacement properties.

Mendola: There seems to be plenty of 1031 money looking for a home in self-storage. Investors realize there is a sunset provision to the Bush 15 percent tax on capital gains. Also, the gain on the recapture portion of the increase is still at 25 percent. There are a lot of savings to be had with a 1031 exchange.

Minker: There appears to be more 1031 money in the market as investors of all kinds of real estate try to maximize gains in existing properties and seek different types of investment products to purchase in a somewhat favorable financing market. They are of the mindset that higher interest rates could make future sales/purchases more difficult.

At the same time, with capital gains rates at low levels, should an investor not find a replacement property, the tax burden wont be as great as it was in the past.

Barnhill makes some very subtle and valuable observations on paying the tax. I think running the math against the new depreciation laws may yield a surprising answer.

WHAT WERE SELF-STORAGE RENTAL RATES AND OCCUPANCIES LIKE IN 2003? HOW DO YOU SEE THIS CHANGING IN 2004?

Barnhill: Rental rates have been fairly stable in our area, but we still are seeing cost incentives available. Overall, occupancies should remain stable in our region during 2004.

Crowe: The rates in California range from $1 to 1.60 per square foot, with occupancies averaging in the 90-plus percent range. There are some pockets that are different, but the market should be strong in 2004.

Eisenman: It varies by market but, generally, occupancy was high. I cannot predict, but we may see occupancy rates decline unless the economy improves.

Hayes: Rental rates and occupancy have remained stable with only a few rental increases. New facilities coming on the market will absorb most of the potential to substantially raise rents or increase occupancy.

Mendola: In 2003, occupancy came down to 80 percent from 90 percent for well-positioned properties in our market. We are missing the increase in job formation along with the moves and housing formations, as well as consumer confidence that accompany them. With Bushs tax plan now in effect, job formation should increase significantly in 2004 and 2005.

Minker: Self-storage rental rates in much of the North Texas market were almost flat. In fact, owners who were keeping rates flat had to increase discounts to maintain existing occupancy levels in the face of increasing competition. Therefore, even if unit occupancy remained stable, economic occupancy, in many cases, fell. As to occupancy in mature properties, owners struggled to maintain existing levels. Overall occupancy rates declined throughout the market.

It is clear more product and a slower economy are having some impact. It is amazing that occupancies and cap rates can go down at the same time; eventually the trends will be parallel.

ARE BUYERS CONCERNED ABOUT VACANCIES OVER 10 PERCENT? GENERALLY, HOW IS THIS CONCERN HANDLED DURING THE SALES PROCESS?

Barnhill: Some buyers view a significant vacancy factor as a buying opportunity, since they would hope to buy existing rental occupancy and enhance income through more effective operation.

Crowe: There is always concern with vacancies! More service for less money is what happens when the supply exceeds the demand.

Eisenman: Yes, particularly if vacancies are significantly greater than 10 percent. It causes the buyer to look much harder at the market and the facility. Rarely will a buyer ignore large vacancies as solely a management issue. Purchase price reflects all factors: market, management, occupancy, facility condition, rental rates, etc.

Mendola: Yes, buyers are concerned about greater than 10 percent vacancy rates in the Northeast because we are used to 90-plus percent occupancies. I talk about our missing customer coming back in 2004, the high-tech and financial-industry job formation the stock market is pointing to this year.

Minker: Buyers seem to have come to expect occupancy to be less than 90 percent. They are less willing to capitalize income that is not currently there. Buyers are looking at the current overall market condition and trends. If they view the vacancy as an opportunity, they may be willing to factor some incremental amount in their offer to reflect it. However, if they view the occupancy to be flat or in a declining market, they might, in fact, submit a reduced offer to offset the market risk.

Significant vacancies are a classic issue of the glass being half full or half empty. The opportunity or problem is in the eyes of the beholder but for sure they wont pay an 8 percent cap on the vacancy.

ARE YOU SEEING MANY DISTRESSED SELF-STORAGE PROPERTIES AND/OR FORECLOSURES?

Barnhill: The availability of distressed self-storage properties is extremely limited in our area at this time. Foreclosures could certainly become a factor as new construction continues and given an environment of rising interest rates.

Crowe: Not in California.

Eisenman: No, not in my territory.

Hayes: None here.

Mendola: No. In the Northeast, properties are in strong hands and excess supply is temporary in most markets.

Minker: We are not currently seeing distressed self-storage properties or foreclosures coming to the market. Owners with troubled properties are somewhat putting their head in the sand, anticipating the market will get better and enable them to sell their properties under more favorable conditions. Unfortunately, it may be some time before these favorable conditions exist.

We are following a couple of recently built projects that are leasing very slowly in predominately soft areas. The numbers do not look good, but there is still some time left on the loan.

Michael L. McCune has been actively involved in commercial 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 nations 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.