This month, I gathered real estate experts to discuss the state of self-storage in the Southeast. Lets hear what they have to say about their respective cities and regions. Our panel includes: Bill Barnhill, Omega Properties, Mobile, Ala.; Dale Eisenman, Midcoast Properties Inc., Hilton Head Island, S.C.; Kathleen OBrien, Wexford/OBrien Associates, Arlington, Va.; Chuck Shields, Beacon Commercial Real Estate, Conshohocken, Pa; and Frost Weaver, Weaver Realty Group, Jacksonville, Fla. While Barnhill also works in Alabama and Mississippi, his responses below refer to the Florida Panhandle. Shields area covers New Jersey and Pennsylvania, but his following responses refer to the Delaware market. My comments are in italics.

As you look back at the last two years, what do you see as the primary reasons owners sell their self-storage properties?

Barnhill:

Owners generally sell to complete a 1031 exchange into another property or due to changes in their life. Sometimes they are planning retirement or simply want to have freedom from day-to-day involvement in managing the operation.

Eisenman:

The reasons vary, of course, but usually some life eventsuch as retirement, relocation or reallocation of assetsseems to precipitate a property coming to market. Sometimes a commercial property that was a good fit for an owner in the past no longer suits his investment objectives. An owner may want to diversify among other types of properties, or convert some of his equity to a more liquid investment.

Potential buyers often ask why an owner is selling, as if to suggest that if it was a good property, the owner would not part with it. Thats a flawed assumption. The buyer should be asking why he should buy the property. If the investment fits the buyers objectives and parameters, it should be pursuedregardless of the sellers situation. If the property has some negative issues, the buyer will discover those as he investigates the opportunity. So, in a nutshell, sellers sell when the timing is right, based on their unique circumstances.

OBrien:

Owners have made the decision to sell for the traditional reasons: The time is right due to a life change, such as a move or retirement. In addition, there are owners who have perceived such high demand for self-storage they believe their class-B or even class-C property will attract strong investor interest.

Shields:

Buyers have told me life changes were the reasons owners chose to sell. The main reason was retirement, with the breaking of partnerships as the next cause. This has been my experience in other areas as well.

Weaver:

Owners have decided to sell their self-storage properties for some of the following reasons:

I cant add much to what our troops in the field are saying, except that if you want to sell, prices are the highest they have ever been. Unless you believe interest rates will drop farther, this is probably a once in a generation (maybe lifetime) chance to sell at high prices.

Do you think the potential rise in interest rates will affect cap rates in your area? What effects on property values do you foresee?

Barnhill:

Rising interest rates will obviously affect cap rates, though not necessarily in a linear fashion. Values should moderate somewhat due to higher cap rates. On the other hand, inflationary pressures could cause an increase in rental income.

Eisenman:

Yes, to some degree, but the long-term rates have been fairly stable recently, so it may be a bit early to predict. As long-term rates increase, we may see a dampening of demand, particularly if it is associated with tighter underwriting by lenders. However, rates and lending criteria are only part of the picture. Values will remain attractive if the industry continues to offer reasonable returns to investors. If we find ourselves in an overbuilt market with softening rents, rising interest rates will have a chilling effect on demand and value.

OBrien:

Yes, of course. The bottom line is always going to be return on investment. The lower interest rates allow more aggressive cap rateseven 7 percent and 8 percent. However, a rise in interest rates will be followed by investor intolerance for lower cap rates.

Shields:

The thinking of some owners is interest rates will stabilize during the first half of the year, with the second half being uncertain due to the war and state of the economy. The feeling is if there is any movement, it wouldnt be more than 1 percent; and values would definitely be affected, but Im not sure to what degree.

Weaver:

A rise in interest rates should increase cap rates, as there is a direct correlation. As rates rise, I would expect to see a decline in values, all else being equal.

Once again, the team is on the money. It is simply axiomatic that higher interest rates cause cap rates to rise and prices to decline.

What are the primary reasons buyers are interested in self-storage as opposed to other real estate investments?

Barnhill:

Self-storage has become a highly desired investment since many investors view it as a low-maintenance property type with ease of entrynot to mention the excellent return self-storage affords.

Eisenman:

Self-storage has proven to be a consistent performer over time (with the possible exception of about six months after 9/11). It offers solid returns and seems to be less vulnerable to fluctuations in the economy. Additionally, because a self-storage property has multiple tenants, no one vacancy has the same impact on cash flow as one might experience in retail, office or industrial real estate. While it shares that characteristic with multifamily properties, it requires less of an investment to make a unit available for the next tenant.

When I speak with potential buyers who are new to the industry, I find they often think the industry is a way to make easy money. I try to explain the home-run opportunities are more rare than they once were, but the industry offers solid singles and doubles for those who are willing to be diligent and serious. Many newcomers underestimate the management component of self-storage and fail to see the associated risks with an under-managed or poorly managed facility.

OBrien:

I think the initial reason is the perception that self-storage requires less management. This is not true, of course. However, I think many investors are attracted to self-storage because it does not require an ongoing capital investment after the initial construction. In addition, the tax advantagesmainly with the shielding of passive incomeare quite appealing.

Shields:

Self-storage is considered one of the best investments available. Expenses and management are very reasonable, and the returns can be substantial. In addition, financing has become more favorable.

Weaver:

I have had contact from potential investors who have been actively involved in the ownership of other types of real estate and are now seriously considering self-storage.

Some of their reasons are:

I think one of the overlooked advantages of self-storage properties is the low cost to turn over a tenant. There is no tenant finish, no leasing commissions, not much cleanup, and not a lot of administrative time and effort. Over the life of most real estate properties, these can really add up, diminishing property value.

Is overbuilding a consideration for buyers in your area? If so, describe their concerns.

Barnhill:

Potential buyers are prudently aware of the overbuilding issue, and most are using market studies as part of their due diligence. An overbuilt market can emerge in a relatively short time, depending on changes in supply and demand.

Eisenman:

Overbuilding is always a consideration for buyers and sellers and will continue to be so. Our industry will benefit from sharing more information that allows better, more informed decisions. While some owners or operators feel they need to safeguard their rental rates and occupancy for competitive reasons, the more enlightened members of the industry recognize that failing to share accurate information can lead to destructive overbuilding, market cannibalization and lower rents.

OBrien:

The population in the mid-Atlantic region is growing in such leapsand the growth projections are so greatthat many buyers are quite eager to enter the market.

Shields:

Overbuilding always seems to be on self-storage owners minds. Some Delaware owners feel New Castle County and some of the beach areas could see some overbuilding but, at the present, it is wait and see as to how the population grows in these areas over the next few years.

Weaver:

Overbuilding has primarily taken place in the larger markets where you have a strong presence of national and regional developers. The smaller markets are continuing to experience good occupancy and stability. Most owners in these markets are reluctant to raise rates for fear of attracting new competition.

Great returns on real estate properties always create overbuildingits just a matter of how much. The overbuilding fires always burn brightest with the oxygen of low interest rates. It is the paradox of real estate that moderation in interest rates is the best position in the long term, even though low interest rates can look really great in the short run.

Is now the time to sell? Rate the local selling environment on a scale of 1 to 10 (with 10 being the most favorable) and explain your answer.

Barnhill:

Now is a window of opportunity to sell, since demand for self-storage is strongand interest rates are still low. Combine this with a low capitalgains tax rate and the opportunity to defer gains through a 1031 exchange, and the result is the best time to sell in the past decade. A rating of 9.5 is not too high.

Eisenman:

Its time to sell only when a sale fits the owners objectives and goals, no matter what the calendar states, interest rates suggest or the owner hears at an industry conference. The proper timing for buying and selling is unique to the individual or organization involved, measured solely by circumstances important to him. For some, now is absolutely the right time to sell, so on the scale, its a 10. Historically low interest rates, reasonable underwriting by lenders and attractive returns make it a good time for buyers to buy and sellers to sell at fair value.

OBrien:

Nobody has a crystal ball, and this is a question each owner has to evaluate. There are many concerns about what the Fed may or may not do; we would all like to predict what the capital markets will do.

Shields:

Some owners believe that self-storage values have topped out. If there is consideration to sell in the next 24 months, its probably better to sell now than later. If interest rates go up, it will be much harder to finance the projects at higher values. On the scale, Id say the rate is 7 to 8.

Weaver:

Unless an owner/investor plans to hold his property for at least five more years, now is the time to sell. I would say the rating is an 8. There is a strong consensus that interest rates are going to rise over the next few years. This is definitely going to have an impact on value. Most markets have sufficient excess supply, and rental rates are not going to offset this declineit would take at least five years for that to occur.

I agree 8 is the minimum rating and 10 may well be the answer. But if interest rates rise, that number will fall to 5 or lower.

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 1994, he created the Argus Self Storage Real Estate Network, now the nations largest network of independent commercial real estate brokers dedicated to buying and selling self-storage facilities. For more information, call 800.55.STORE or visit www.selfstorage.com.