Every other type of commercial real estate spends huge amounts of money to acquire new tenants. Office-leasing brokers often collect a dollar per year per square foot of space leased, and the landlord pays as much as $25 to $45 per square foot to remodel the space.
Retail, industrial and hotels have their own unique but expensive ways of acquiring tenants. Self-storage seldom requires large capital expenditures of any kind, and rarely does an empty unit require material refurbishing after a tenant moves out. The apartment landlord can only dream of this situation as he repaints, buys appliances or installs carpet between each tenant.
The most important factor contributing to the effectiveness of self-storage is leases are usually 30-day contracts. This allows the owner to adjust rent at any time and react quickly to changes in the market. Increases can be as frequent as the owner wants, and can be relatively small in dollar terms but significant in percentage terms. Apartment leases, on the other hand, usually run 12 months, and other types of real estate lease terms are usually counted in years.
This ultimate flexibility allows self-storage owners to take advantage of lowering rates when demand is low and raising them when demand is high. Many self-storage management firms adjust their “street” rates every day, sometimes more than once a day, and set schedules for each tenant’s future rate increases, sometimes as often as twice a year. The ability to manage revenue is an important and distinctive characteristic of self-storage.
Finally, most self-storage owners have a conservative streak that provides a lot of security in these troubled times. Most have a responsible amount of leverage in their properties. This trait not only protects owners, it collectively helps preserve an orderly market for those that want to sell or buy facilities. Many, if not most, other commercial real estate owners are leveraged to “the hilt.” By way of example, there are a trillion and half dollars worth of commercial mortgage-backed securities loans maturing in the next three years.
To a large measure, these positive fundamentals of our business have saved the day for self-storage owners—so far. First, let’s remember what the first six months of this debacle looked like in terms of the commercial real estate market. The REITs’ stock values plunged because of the projected decline in property value and, more important, their excessive debt and the close maturity of that debt.
Many of the REITs have scrabbled hard to raise equity and refinance maturing loans, but it was at great expense to their shareholders in terms of dilution of share value. The combination of the high leverage on most of the commercial real estate loans and the close maturities make their repayment problematic. The banks―and not just the big ones―simply do not have the capital or risk appetite to make new loans or renew the existing ones. That’s not to say new loans are impossible, but they’re going to be difficult to find and will have dramatically less generous terms.
Current interest rates are in the 6 percent to 8 percent range, with a loan term of 3 to 5 years―on a very good day, maybe 10 years. The underwriting of the loan will be more strenuous, with the value determined by the trailing 12 months of net operating income divided by the cap rate. No pro forma income or excessive “other income” is likely to be counted in the calculation of value. In most cases, the loans will provide for recourse to the borrower, which is a significant change from the CMBS loans they may replace.