By Tony Jones
Despite the hardships suffered by many self-storage owners during the last three years, the flexibility afforded to storage facilities has helped the industry adjust to market fluctuations and avoid the devastating declines experienced by other commercial real estate segments. Low capital expenditures on existing facilities, short-term contracts and frequent rental-price adjustments have enabled many owners to ride the ebb and flow of supply and demand to protect property performance and value.
“We have seen rentals start to increase or at least flatten out, and most of the discounting is being slowly squeezed out of the market,” notes Ben Vestal, president of Argus Self Storage Sales Network Inc. “This is bringing more stability to the investment class and, more importantly, the financing of self-storage investments.” As a result, the self-storage real estate segment has teetered but not fallen and emerged from 2009 transaction lows squarely as a buyer’s market.
“A greater number of buyers have emerged for existing facilities, and they have been more particular on the property types they look to own,” explains John Barry, vice president of brokerage for Investment Real Estate LLC. “They are seeking quality properties in excellent locations and will pay a fair price for these, or they are looking for extremely reduced prices on lesser class facilities.”
The crux, of course, is financing remains a challenge for many would-be buyers, and changes in valuation underwriting have made brokering deals more difficult for sellers. “Demand and rates appear to be bouncing along the bottom, not knowing whether we are improving, or just holding the line on performance,” says Vestal. “There are several buyers in the market for well-run, stable investments. The valuations today are subject to new underwriting criteria that are here to stay. The new reality is that the commercial real estate market has more to do with the value of your self-storage facility than the performance of the actual facility.”
By most accounts, transaction volume in 2010 surpassed 2009 activity, but that upward movement was tempered somewhat with more properties being moved into foreclosure and lenders accepting short sales, notes Barry. Nevertheless, “because more opportunities have developed in the market, more buyers have appeared, and the offers have tightened up quite a bit,” he says. “I would expect to see that trend continue this year.”
Market conditions overwhelmingly favor well-capitalized, experienced buyers and have put a crimp into transactions under $3 million. Large, high-value properties are achieving cap rates 100 to 300 basis points lower than smaller, less valuable properties, Vestal says, creating a gap that makes it impractical for cash-rich buyers to broker smaller deals.
“Well-capitalized buyers in the market today are unable to obtain smaller loans at a competitive rate that is necessary to make the smaller deals work,” explains Vestal. “Additionally, they are unable to achieve the economies of scale necessary to make their new financial model work.”
That leaves smaller operators dealing with buyers who either do not have sufficient capital or cannot get favorable interest rates and terms from lenders uneager to jump into smaller transactions.
“It is still very difficult to transact a deal today due to the lack of high-leverage financing tools and, more importantly, the lack of liquidity of small real estate investors,” notes Vestal.
Conversely, 2010 was marked by several large transactions and portfolio sales. In some markets, like California, transactions were essentially frozen except for portfolios or distressed properties, according to Stephen Grossman, senior vice president, Self Storage Investment Group. “Portfolio sales have been occurring more frequently than ever,” he says. “The motivating factor for these sales has primarily been the need for new financing.”