Now is a great time to be an opportunistic investor in the self-storage market because there is more selection and properties are underwritten on fundamental economics and actual net operating income (NOI), not on pro forma and projections that properties were selling for a few years ago. Investors can achieve low double-digit cash-on-cash returns. Properties selling right now are operating deals clearly underwritten with appropriate reserves, increases in taxes, escalations in insurance with external management and expenses that are optimized for the new buyer.
Between 2003 and 2006, all the risk in a self-storage transaction was borne by the buyer because of the ample liquidity in the capital markets. Whatever the seller wanted, the buyer had to acquiesce. The risk has now shifted to the seller because of the global financial crisis, which has caused yield requirements to increase and resulted in fewer buyers in the market. Many buyers are sitting on the sidelines, believing there is more downside in pricing. As a result, sellers have to be more flexible to deal with fewer buyers in order to close transactions.
The Money Game
Assumable financing has emerged to play a larger role in the investment sales market, and seller financing is making properties very attractive. Nonetheless, financing remains a challenge. Since local and regional banks are primarily providing financing for properties, brokers and the investors they represent should have sound banking relationships. From 2004 to 2007 virtually any investor—no matter how little experience he had in operating self-storage facilities—could obtain acquisition financing; but today lenders are looking for owners with experience, or ones who agree to hire professional management companies.
The gap between buyer and seller expectations remains relatively far apart. It’s imperative that you utilize a third-party representation when entering into a transaction. A third-party intermediary is necessary to navigate the difficult lending environment, obtain optimal underwriting, overcome objections in the current market and find the upside potential that may or may not be obvious.
In the previous years, many brokers became accustomed to order-taking, placing their listings on the Internet and selling them in a relatively short time period. Since that is not happening today, we will see the cream rise to the top and the best brokers will be successful as we move into the new year.
Although investment sales activity has slowed, the stronger self-storage markets are in the Midwest and Northeast. Solid markets include Boston; Buffalo, N.Y.; Northern California; Seattle and Washington, D.C. Well-located, primary market class-A quality construction are still sought after among private investors, and these assets are commanding cap rates of 7.75 percent.
For class-B and C product, cap rates remain in the 9 to 10 percent range, depending on the asset’s location. In addition, a few years ago, there was little spread between the A, B and C product in terms of cap rates and pricing. Now that gap has become much wider. There is much less risk in well-managed, prime, class-A product versus older, privately run and managed facilities that are in secondary and tertiary locations. We expect to see some pockets of softening in markets that were hit hardest by the single-family housing market fallout, including Riverside-San Bernardino, Calif.; Miami and Phoenix.
The success of the self-storage market is tied to consumer confidence and the single-family housing market. To the extent that the housing market improves will determine how quickly self-storage fundamentals will shore up. By all accounts, we have about another year. As the Troubled Assets Relief Program (TARP) and other government bailout programs to infuse some liquidity into the national economy, and as Fannie Mae and Freddie Mac’s operations continue to be streamlined, the more confidence will return to the market.
Steve Ekovich is the national director of the National Self-Storage Group of Marcus & Millichap Real Estate Investment Services. For more information, call 925.953.1716; visit www.marcusmillichap.com.