The Self-Storage Industry’s Extraordinary Times: How Long Will They Last?

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By Ben Vestal

Now’s a good time to buy, sell or refinance a self-storage property. The effects of the continuing low-interest-rate environment and increased investor confidence have been a boon for owners looking to sell or refinance as well as buyers on the market.  

During the relatively brief history of the self-storage business (35 to 40 years), public perception of the industry has changed dramatically. Wall Street has embraced self-storage, and life-insurance companies and conduit lenders have come back to the market, enamored once again with lending on properties with terms similar to core asset classes such as office, retail and industrial.

Along with the respect the self-storage industry has earned over the years has come an increase in competition. Facility owners are now realizing that sophisticated operations and economies of scale are imperative to business survival. This is more apparent than ever before as we see large operators winning business away from smaller ones, whether by pricing, advertising or property amenities. In general, the large operators are able to get a rent premium over small operators with similar properties in the same markets. This leads me to believe the industry has reached a crossroads, and operators need to make the necessary adjustments to compete as self-storage matures.

The effects of the continuing low-interest-rate environment have had a dramatic impact on self-storage investments over the last six to nine months. The most obvious and positive result is owners are able sell their properties at close to historically high prices (reflecting on 2006 and 2007) or refinance and keep a larger share of their hard-eared income by paying less to lenders. Let’s not forget that just 12 to 18 months ago, the general consensus in the commercial real estate industry was that many owners would be facing maturity defaults, as property values had fallen as much as 40 percent and there were very few lenders willing to commit to new loans.

We’re now seeing values rebound faster then anyone thought possible. Low-leverage refinancing deals are again able to achieve non-recourse loans with terms very similar to the peak of the market. Higher-leveraged deals also seem to be finding a home, albeit at higher interest rates and with strong personal guarantees. This is not to say ill-conceived projects or properties bought with unrealistic expectations during the boom of the mid-2000s are not still struggling. These projects will continue to struggle and slowly work their way through the system. As they say, time cures almost anything; this seems to be also true about the real estate business.

The other noticeable impact of low interest rates has been on the pricing of self-storage facilities in relation to their income. This is, of course, in recognition that new buyers will be able to obtain financing at lower rates and achieve higher returns. In essence, each dollar of income becomes worth more to a buyer. Using typical market rates (capitalization rates) for computing this increase in value, on average a project would have gone up about 15 percent over the last year or so, with no increase in net operating income, largely because of the compression in cap rates over the last six to nine months.

However, it is important to note that as the self-storage industry matures, the sophisticated capital and operators who are able to pay the highest prices are now drawing a line in the sand between institutional- and non-institutional-grade properties. This has led many small operators to wonder why they can’t achieve the same low cap rates as other properties in the market. This bifurcation in value between large and small properties and large and small markets will continue, and many of the smaller operators will be faced with a difficult decision.

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