This month, I gathered real estate experts to discuss the state of self-storage in the North-Central United States. Let’s hear what they have to say about their respective cities and regions. Our panel includes: Bruce Bahrmasel, The Preferred Realty Group, Lincolnwood, Ill.; Larry Goldman, Prudential Commercial Real Estate, Kansas City, Mo.; Matt Libman, The Preferred Realty Group, Lincolnwood, Ill.; and Robert Off, Coldwell Banker Commercial, Cincinnati. I asked these brokers straightforward questions every owner and potential buyer will find pertinent. My comments are in italics.
1. What are the cap rates for “reasonably” projected incomes in your market? Describe your view of the recent cap-rate trends in self-storage.
Goldman: Cap rates continue to remain in the 8.5 percent to 10.5 percent range, depending on the outlook for future growth of a property and the amount of exposure it receives from prospective buyers. Several properties have sold for cap rates below that range, with buyers relying on a longer time frame to achieve stabilization. Cap rates will start to increase as interest rates increase. The question is, how much will the fundamental performance of the properties start to improve (or decline) to offset the increase of the cap rates?
Libman:I see cap rates on projected 2005 income in the 9 percent to 10 percent range. In general, cap rates have been hovering below 10 percent and are still in step with current interest rates. I also expect cap rates to increase as interest rates rise.
Off:“Reasonable” means different things to different people. Unfortunately, from a brokerage perspective, there have been very few self-storage sales in my market over the past few years—though a number of facilities have been actively marketed and then withdrawn from sale. I think this is a direct result of the unrealistic expectations of the owners. The Midwest is not the hotbed of speculation that Arizona, California and Florida are. Consequently, our buyers are not willing to pay 6 percent, 7 percent or 8 percent caps for self-storage properties. With that said, I think an appropriate and reasonable cap rate for our markets is in the range of 9.5 percent to 10.5 percent of trailing NOI, depending on the facility condition, location, etc.
It’s beginning to look like the cap rates will move up with interest rates. They have to do so to keep the returns up for investors. Also, I would not be surprised to see the general level of cap rates go up in response to concerns about overbuilding—maybe a lot.
2. Is there more or less 1031-exchange money in the market now than in the past? There seems to be a lot. Do you see this changing?
Goldman:There is an enormous amount of 1031 money chasing self-storage investments. Many apartment investors are trading into the storage business because of the relative ease of management. However, these 1031 buyers may start to dwindle and quit chasing replacement properties as the prices go beyond reasonable levels.
Libman:There is more 1031 money in the marketplace than one or two years ago. The real estate market is active across all sectors, and more 1031 money is flowing from all types of investments. If interest rates rise and the real estate market cools, we could certainly see a decrease in 1031 exchanges. However, we find that money is shifting from residential and traditional commercial investments to self-storage. One owner in the Northwest is in the process of liquidating a portfolio of apartment buildings and looking to acquire or develop several storage facilities.
Off:I’ve been selling real estate in the Midwest for more than 25 years, and during that time, I’ve heard of and gotten more inquires about 1031 exchanges than I care to think about. I have seen few of them end well for the buyer in the long term. Today, the “street talk” about exchanges is escalating to a shrill with the arrival of TICs (tenants in common). Time will tell, but with today’s low capital-gains tax rates, I would pay the tax and move on.
I’m inclined to agree with Off. When you run the numbers, the amount you save with a 1031 exchange is not much in comparison to being sure you get the real estate you want, when you want it. Getting someone else’s “hand-me-down” property might not look like such a good deal. Take your time—this is a tricky market.
3. Is overbuilding becoming a significant factor in your market?
Bahrmasel:Each local market, submarket and trade area is different. Many secondary and rural markets have not attracted competition from large regional and national firms. The addition of one facility to a small community could affect the entire marketplace.
Goldman:In much of Kansas and Missouri, development slowed in 2003, and absorption increased in 2004. In many submarkets, as 2005 projects begin their lease-up, the consequences of overbuilding should show themselves in 2006.
Off:The question should be: Where is overbuilding not occurring? If I knew the answer, I would be on the next plane. I think the only folks who think overbuilding isn’t a problem are the self-storage manufacturers and contractors.
If the new numbers for the major Metropolitan Statistical Areas are anywhere near correct, overbuilding is a problem almost everywhere. Survey your market to see what is being planned and built. If general occupancy levels are below 85 percent, there may well be a serious problem.
4. Are buyers concerned about vacancies of more than 10 percent? How is this concern addressed in the sales process?
Bahrmasel:Buyers are not overly concerned about a 10 percent vacancy in our market. In fact, most buyers look at an 85 percent economic occupancy as being a “stable” figure.
Goldman:It depends greatly on the perception of the overall growth of the area and the confidence in the incoming management team. In many markets, 80 percent to 85 percent is considered to be stabilized in the near term.
Off:The 10 percent vacancy threshold has been largely passed in my market. Owners today—though not happy about it—aredealing with vacancies in the 15 percent to 20 percent range. To make up for these lost dollars, smart operators are seeking to enhance revenues by adding new profit centers such as retail sales, equipment rentals, self-service car washes, wine storage, records storage, etc.
5. What is the status of financing for experienced buyers? Are industry newcomers having a hard time getting money?
Goldman:I have not seen any lack of enthusiasm on behalf of lenders for most selfstorage investments. Keep in mind that while storage has suffered from overbuilding and declining fundamentals, many other property types have fared far worse. And lenders still need to lend, even if they have to reduce their spreads.
Libman:Experienced buyers are obtaining financing without any trouble. Newcomers are also able to get financed—more often through small local banks familiar with the projects and geographic area.
Off:Financing for larger loans made to larger owners is very competitive. It’s clear the financial institutions have money to give. In addition, self-storage loans are particularly attractive to these lenders because, historically, the default rate has been one of the lowest of all real estate types. However, smaller loans continue to be a bit tougher to get, and the terms depend, to a large degree, on the quality of the property, the track record of the borrower, and the facility’s balance sheet.
There is still a lot of money chasing every deal. How long this condition will last is anyone’s guess, but I’m guessing that sooner than later, the party with cheap money and generous loan-to-value ratios will begin to disappear.
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 nation’s 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.