Self-Storage Performance in a Recession: Why This Slump Is Different From Past Downturns

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Corresponding to the rapid rise of storage space, rates of return, or capitalization (cap) rates, plummeted. The typical cap rate for a self-storage facility up to about year 2000 was in the 9 percent to 10 percent range. This was looked upon as the norm, or the “Goldilocks range,” without much variation.

Beyond 2000, cap rates declined, with many markets showing transactions in the 6 percent range. Even secondary markets experienced exceedingly low rates, which did not make much financial or market sense based on the underlying level of risk. This was viewed as cap-rate compression, where cap- rate tiers reflecting location or geographic market distinctions did not appear to exist.

In this expansion period, it was rare that the question was asked if new construction or more storage space was even needed. Markets known for having overbuilt conditions in the past saw new product enter, often from first-time developers anxious to get in the storage game. Many of these markets had low barriers to entry or cheap land. At the end of the development boom in 2007, the industry found itself with far too much storage space and was, for the most part, overbuilt.

The Recent Recession

With this recession, many existing and prospective tenants exited the storage market. The use of storage became a discretionary expenditure, with tenants opting to get rid of excess personal goods.

Commercial users of storage space who typically rented larger units also left the market. These tenants included small contractors and entrepreneurs using storage for inventory and equipment storage. Without construction jobs, the tile, flooring and drywall contractors disappeared as their need for storage evaporated. For many markets, the current level of self-storage space should satisfy demand for the next 10 years.

In an unexpected twist and despite economic declines, self-storage facility values have increased over the past six to nine months. This turnaround does not reflect a change in the underlying fundamentals of storage—there’s still too much available space and flat or shrinking demand. It primarily reflects the low-interest-rate environment being faced by investors. The lack of alternative investments that offer reasonable return opens the way for self-storage to provide higher return.

In 2009, self-storage cap rates were pushed into the 8 percent and 9 percent range. This was probably good for the industry, as these rates were considered more commensurate with the level of risk. They were viewed by many as representing fair return reflective of the use characteristics of self-storage.

The downward pressure on cap rates now stems from the low-interest-rate environment as well as large of amounts of sideline capital willing and needing to be placed. Some of this capital is flowing into self-storage. Most of the transactions taking place are typically of secondary properties in overbuilt markets or ones having some problematic condition. In many cases, the cap rates tend be low but are setting precedents for future transactions. It’s important to note that the historical condition of the market still remains intact in that the good and well-located properties rarely sell.

A review of numerous transactions reveals a large number of cap rates in the 7 percent range. Although considered low based on the risk levels associated with many of these market areas, the lack of alternative investments is placing this downward pressure.

Given that storage revenue is probably at or near the bottom, it’s probably reasonable to see cap rates for class-A facilities in the 7 percent range, and class-B and -C facilities achieving a 100 to 200 basis point risk premium, leaving them in the 8 percent range.

While the self-storage industry continues to be resilient, industry dynamics are different in the current economic climate than during past recessions. Many markets are overbuilt, consumer behavior has changed, and revenues and occupancies are in decline. Even still, a lack of alternative investments is putting downward pressure on cap rates, and facility values have managed to increase.

Jeffrey Rogers and Matt Swanson are part of Integra Realty Resources Inc., an independent commercial real estate valuation and consulting firm. The company specializes in real estate appraisals, feasibility studies, market studies, expert testimony and related property-consulting services. Rogers is president and chief operating officer. To reach him, call 212.255.7858; e-mail jrogers@irr.com. Swanson is managing director and principal of the company’s Los Angeles office. He can be reached at 626.792.2107 or mswanson@irr.com.

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