This month, I gathered real estate experts to discuss self-storage in the North Central United States. Lets hear what our local experts have to say about their respective cities and regions. Our panel includes: Larry Goldman, Prudential CRES Commercial Real Estate, Kansas City, Mo.; Robert Off, Coldwell Banker Commercial, Cincinnati; Bruce Bahrmasel, The Preferred Realty Group, Chicago; Dustin Whitehead, Lockard Realty, Waterloo, Iowa; Paul Svenvold, Coldwell Banker Burnet, Minneapolis; and Peter Hitler, Investment Real Estate Specialists, Milwaukee. My comments are in italics.

With the rising trend in interest rates, what are the concerns of buyers and sellers in your market and how have attitudes changed?

Bahrmasel

: The interest of first-time buyers has cooled somewhat. However, owners still have a good appetite for acquisitions. Sellers have pulled back from listing and seem to want to hold onto properties. Some owners were prompted to sell because of low interest and cap rates (5.5 percent and 7.5 percent, respectively), but now they are listing property for more traditional reasons.

Goldman

: The rise in rates has brought a sense of urgency to the market. I think the industry is in a shake-out period of prospective sellers who are concerned about stagnant or declining performance and now want to sell before interest rates climb too high.

Hitler

: Were seeing a slight increase in the number of people selling. I think sellers are realizing we have left the top of the mountain and interest rates are slowly going up, reflecting a lower selling price.

Off

: As interest rates increase so do capitalization rates, which means prices decline. This is particularly true in non-institutional properties. Owners were slow to catch on to the situation but seem to be focusing now. They may be a bit late, but there is still time.

Svenvold

: I see more non-metro facilities listed for sale. I think some sellers are listing now before rates climb higher. I still see prices that dont make sense, most of which stay on the market without selling, indicating few sellers have changed their attitude.

Whitehead

: Buyers still want lower loan rates, but its harder to find them. Lenders have started to tighten lending requirements. Sellers attitudes are unchanged, but theyll likely react with higher asking cap rates.

Cite an example of overbuilding in your area and describe the repercussions.

Bahrmasel: An interesting example occurred in a suburban location where a nice facility came into a saturated market. Owners in the area were able to beat the new facilitys prices, making lease-up difficult. The owner was forced to sell his project long before he could stabilize it. He sold about six months ago, when low interest rates still made his project attractive to investorsa scenario that wouldnt occur today.

Goldman:

Over the past eight years, Ive seen a herd mentality of facility building and expansion, triggered by periods when demand catches up with supply. The end result is declining occupancies. Unsophisticated owners may drop rental rates, indefinitely depressing the entire submarket over the long term. Savvy owners generally will give concessions with time frames, limiting the damage to long-term performance. Regardless, the outcome is lower revenues.

Hitler:

Overbuilding hasnt been a problem in Wisconsin, with a few minor exceptions. Occupancies are down a bit but still robust at 85 percent and higher.

Off: About a year ago, I got a call from an owner who built a facility but realized self-storage was more of a business challenge than hed bargained for. I suggested he try to sell for the amount invested or possibly take a small loss. He chose to continue leasing, hoping to increase his NOI and value. A few months ago, he called to report a new competitor had just opened down the street. Our conversation was not about a possible sale, but rather how he could stay above water while the competition cut prices and caused havoc in his market. I think he wishes he had sold and took a small loss. As they say, Often your first loss is your least expensive loss.

Svenvold:

There has been some overbuilding north of Twin Cities and two facilities have been taken back by the lender. The properties are in areas that had a strong supply of storage space but poor highway access. The impact has left an ultra-soft market.

Whitehead:

There hasnt been much overbuilding in Iowa, but we are starting to see many new facilities in areas such as Des Moines that are high growth or have the potential to be. Some owners are concerned overbuilding could factor in the near future, but feel they have the prime location for success. If interest rates continue to rise, new construction will slow, and areas with overbuilding will stabilize.

A new project will always cause existing owners to redefine strategies and business plans. We have developed a survey outline (www.selfstorage.com/argus/toolbox/checkup.htm) to help you better understand your market when competition threatens. The survey assists in determining a long-term strategy and short-term tactical approach.

How is the economy in your area faring and how does it affect self-storage?

Bahrmasel:

Owners are reporting strong occupancies and lease-up activity. Our economy remains vibrant; as long as owners dont saturate an area with new projects, the outlook is good.

Goldman:

Southwest Missouri is seeing strong overall economic growth accompanied by strong absorption of new space. Kansas City is holding its own with more limited growth and slower absorption in a generally overbuilt market.

Hitler:

Wisconsins economy is good. Were not experiencing a boom, but unemployment is low. There are vacancies in the office/warehouse market and industrial buildings. Occupancy in self-storage is strong.

Off:

The Midwest, particularly in Ohio, is suffering a loss of jobs and consequentially the population is shrinking. This creates an environment where buyers are cautious and sellers often disappointed. Facilities are still being bought and sold, but a professional marketing campaign is almost essential for success.

Svenvold:

Minnesotas economy is doing well. Housing starts are forecast to be near or slightly under last year, and single-family home sales are off to a good start, which should be beneficial for the storage industry.

Whitehead:

The economy is soft and some owners are seeing higher vacancy rates than last year. Tenants may be able to be choosier about facility choices if owners begin offering incentives to keep occupancies high.

Are valuations the same in terms of cap rates? Are you seeing as many buyers right now?

Bahrmasel:

Prices for projects are coming down based on todays interest rates. New sellers will probably have to adjust their values to reflect the current interest-rate climate.

Goldman:

Valuations in Kansas and Missouri are still robust as there are far more buyers than sellers. Buyers range from existing storage owners looking to expand portfolios, to 1031 buyers aiming to get out of other properties and into self-storage, which is less management intensive.

Hitler:

We see as many buyers in the market as last year, but theyre not willing to pay as high a cap rate. Facilities with a marginal location have dropped up to 50 basis points. We think this will be an excellent year for storage sales.

Off:

Cap rates are becoming muddled as vacancies increase, expenses grow and individual markets are stressed from competition. This creates a situation where a facilitys value is more often based on future potential income and the underlying asset value of the land and buildings. Gone are the days of simply capitalizing the NOI by some market cap rate formula. Preparing a proper valuation is an art form and best performed by someone with experience and market knowledge.

Whitehead:

Cap rates have increased slightly, ranging from 8.75 percent to 10 percent on Class A facilities, 10 percent to 11 percent on Class B facilities, and 11 percent and up on Class C facilities. There are still many buyers for all facility types. This will continue as more people look at self-storage as an investment vehicle.

According to most of our brokers, cap rates are increasing and prices are softening; however, the biggest variance is still the regional spread in rates. Buyers should take a look at deals in coastal regions. The economies are mostly solid and stable. If you can buy a property on a 9 percent or 10 percent cap rate (as opposed to 7 percent), net income increases by 29 percent or 43 percent, respectively. Thats on the same dollar of investment. See you in Iowa! 

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;visit www.selfstorage.com.