The self-storage industry faces many challenges, but perhaps none as worrisome as the impact the current housing market might have on operating performance and, therefore, facility value.

Youve all seen these types of headlines in the news: Foreclosure rates up dramatically, Home foreclosures up 93 percent nationwide and National foreclosure rates soar. Self-storage investors who were once assured high-yield, low-risk investments are now faced with more competition than everat a time when the housing market is presenting problems for homeowners, the primary users of self-storage.

The tie between the housing crisis and our industry is fairly direct. The primary demand for storage comes from the consumer, and 70 percent of the U.S. Gross Domestic Product is tied to consumer spending. Since people have been tapping the equity in their homes to fund their spending habits, what will happen now that home equities are disappearing and home values are declining?

Due to what some are calling, irresponsibly financed excesses, homeowners are waking up to find their equity is gone; the money has been spent, and credit is harder to obtain. According to an economics study conducted by Beacon Realty Capital, a Chicago-based commercial real estate financial-services company, People are literally spending more than they are earning after taxes for the first time since the Great Depression.

Left with few choices, consumers will have to cut back on their discretionary spending. That could impact the self-storage industry as well as the entire economy. If that isnt bad enough, credit has tightened up, making it very difficult for people to obtain loans for the purchase of those very items that often require storage, such as RVs, boats and trailers.

Oh yes, one more thing: Thousands of homeowners who have adjustable-rate mortgages are seeing their monthly house payments increase dramatically, leaving them with less disposable income to spend on renting storage. Given the existing supply of space, this once recession-resistant industry is now facing the same challenges as every other real estate segmentnamely, the importance of maintaining balance between supply and demand given changes in the economy.

Self-storage owners, investors, appraisers, analysts and lenders are all asking how this will impact industry operating performance and facility value. Its near impossible to isolate the impact of individual aspects of the soft housing market. But we can shed some light on the possible magnitude of its impact, disputing the misguided notion that all of this spells big trouble for self-storage.

The Impact of Foreclosures

Concern about how the soft housing market will impact industry operating performance started early last year when the country first learned there was danger. Now it has become more widespread and the end, according to most, is still a year or so away.

A recent article published in USA Today indicated 179,599 foreclosure filings were recorded in July 2007, up from 92,845 during the same period a year earlier. The national foreclosure rate in July was one filing for every 693 households, according to RealtyTrac Inc., an online marketplace for foreclosure properties. (But remember, not all filings actually end up in foreclosure.) To understand the magnitude of the problem and how these foreclosures might impact self-storage, consider the following illustration using the demographics and supply statistics from an actual facility in a major metropolitan market:

Using the national average foreclosure rate from July of one per 693 households, this neighborhood could expect approximately 68 foreclosure filings per month. If we assume this foreclosure rate to continue for one year, which is unlikely, the neighborhood could see approximately 816 vacant households. Statistics show that only 10 percent of households use self-storage at any given time, translating to approximately 82 self-storage vacancies for this market. Thus, the impact on operating performance would be an increase in physical vacancy of less than 1 percent (82 new vacancies divided by 12,180 currently occupied units equals 0.007, or about three-quarters of a percent).

Current Market Conditions

The good news is the storage industry has continued to perform well. According to research performed by my company, the national average physical vacancy in the second quarter of 2007 was 13.1 percent. Under these circumstances, a 1 percent increase would not have much of an impact on facility value.

The reality is foreclosures themselves are not a threat to self-storage. However, the mistaken belief that increasing foreclosures will negatively impact operating performance will cause appraisers and loan underwriters to increase cap rates to account for the perceived future risk. If theyre really concerned, theyll increase the physical vacancy as well, which would unnecessarily reduce facility value.

My companys research supports the conclusion that the housing market has not had a significant negative impact on self-storage. While median physical vacancy did increase 2 percent in the second quarter of 2007 compared to the same quarter last year, it was the direct result of owners having increased rental rates for ground-level, nonclimate-controlled 10-by-10 units by nearly 8 percent. Upper-level rents for the same type unit increased more than 3 percent on a seasonally adjusted basis.

What we discovered is the net impact of rental-rate increases more than off-set the increase in vacancies and the cost of concessions. This was demonstrated by the 2 percent increase in the amount of rent collected per occupied square foot in the second quarter 2007 versus the same quarter in 2006.

Conclusions

The increased filings of foreclosure will not negatively impact the value of self-storage facilities. Remember, not every filing results in a foreclosure, and not every household that goes go into foreclosure is using self-storage.

Nevertheless, there are self-storage markets around the country that have been hard hit by the economic slowdown, soft housing conditions and an oversupply of new storage facilities that arent doing particularly well. Florida continues to suffer as do parts of some metropolitan areas: Cincinnati, Cleveland, Detroit, New York and Washington, D.C.

The unfounded fears of appraisers, analysts and investors combined with a significant drop in consumer spending could cause self-storage revenue to fall off in the short run. However, most markets are not overbuilt, and a demand for storage could arise from the economic disruption in peoples lives. The loss or downsizing of homes may trigger a need to store belongings until the storm passes. In short, consumer challenges may hold a silver lining for self-storage. 

Charles Ray Wilson, CRE, MAI, is the founder of Charles R. Wilson & Associates Inc., a full-service appraisal firm that specializes in the valuation of self-storage facilities nationwide. He is also the founder of Self Storage Data Services Inc., a manager and publisher of economic and operating statistics relating to the self-storage industry. For more information, visit www.ssdata.net and www.crw.com.