Looking back over 2010, there’s no doubt real estate transaction volume improved significantly compared to 2009. This is largely due to an adjustment in the two most critical factors affecting investor confidence: fear and greed. We’ve seen an improved attitude toward acquisitions, and most self-storage professionals are feeling more confident in their ability to perform as the shock of the recession starts to wear off.
Most of the fear that was in the market last year was created by unknown factors in the financing market and an overall slowdown in the economy. As we approach the end of 2010, we’re seeing improvements in the financing market and, most important, we’re confirming self-storage is no doubt one of the most recession-resistant real estate assets.
Few Distressed Properties
The uncertainty and fear in the market during 2009 was generally created by the unknown factors floating around on the balance sheets of many major banks. The one question out there that still seems to be unanswered is how banks will handle maturing loans where the collateral is no longer worth the balance. You’ve probably heard the term “extend and pretend” by now, as banks have tried to work with borrowers to extend the loan to allow borrowers the necessary time for the market to recover.
The few buyers in the market last year seemed to be waiting for distressed asset opportunities to come to market, hoping they would not overpay. Since it was difficult to assess the market value of real estate due to the lack of transactions, they were simply relying on the assumption that if it was distressed, then they would be not overpaying. The reality is there were actually very few distressed sales in 2009. The ones that did come to market were sold in a noncompetitive environment, which created a tremendous opportunity for the buyers who had access to these deals.
The majority of distressed opportunities that sold were placed in a bidding process where they were so actively chased that it left many wondering whether the winning bidder had actually paid a distressed price. In any event, the few transactions that took place in 2009 were setting the rules by which properties were now going to be valued.
Today the demand for self-storage properties is strong, and there are several well-capitalized buyers in the market. These buyers are experienced and disciplined in their underwriting, and are not willing to overpay. Those winning deals are not winning them on price alone. They’re relying on other factors such as timing, due diligence and experience.
There’s also a substantial bifurcation in the market between properties in major markets, with values of more than $3 million, and smaller, less valuable properties. Higher-value properties are achieving cap rates that are 100 to 300 basis points lower than those for smaller properties. This is because the large, well-capitalized buyers in the market today are unable to obtain smaller loans at a competitive rate necessary to make the smaller deals work. Additionally, they’re unable to achieve the economies of scale necessary to make their new financial model work.
These factors, combined with the high cost of the legal work and the complex nature of the larger operator’s capital, have made it difficult for larger operators to consider smaller transactions in today’s market. This has left the smaller operators wondering why they can’t sell their properties at the same cap rate as larger properties in the same market. The smaller operators are dealing with buyers who are not as well-capitalized and, more important, banks that are less aggressive with interest rates and terms due to the small nature of the transaction. In fact, smaller, less valuable properties will be valued differently than larger, well-located, class-A properties for several years to come.
There’s every indication the transaction market is improving, with market-rate deals dominating the majority of recent transactions. This has led to clarity in pricing and added confidence to the financing markets. Additionally, the concern about a possible double-dip recession, rising interest rates and the likelihood of an increase in capital-gains tax has led some of the most sophisticated owners in the business to consider selling in today’s improving market.
Clearly, any of these events could have a material impact on the owner’s investment if the investment’s horizon is short term, say less than three years. If you’re planning on selling in the not too distant future, you may want to give some thought to accelerating the process to take advantage of lower capital-gains tax and a buyer’s ability to borrow money at low interest rates.
Ben Vestal is president of the Argus Self-Storage Sales Network, a self-storage brokerage network based in Denver. He can be reached at 800.55.STORE or firstname.lastname@example.org .