By Kenneth E. Nitzberg
If you look at the market for the sale and purchase of self-storage assets today, and you’ve been in the sector since at least 2005, at first blush, it would be difficult to tell whether you were in the summer of 2007 at the height of the self-storage market frenzy or if it is really the summer of 2013.
We are once again seeing capitalization (cap) rates for class-A self-storage facilities hit 6 percent and sometimes even lower. If it's a class-A portfolio for sale, it’s likely in the 5 percent range. It’s a great market if you’re a seller and have a class-A facility in a major metropolitan market, but it’s a very difficult time to be a buyer if you have funds to place in the self-storage asset category.
So what’s going on with the market? I believe there are three factors at work, the combined pressure from which is continuing to drive market cap rates down, thereby driving up prices.
The first leg of the three-legged stool is interest rates. They have continued to fall. With the much greater availability of significant amounts of debt, the combination has driven up prices buyers can justify paying. Although interest rates have again moved up almost 100 basis points in the past 60 days, they’re still at or below historical levels of the past 20 years.
Commercial mortgage-backed security (CMBS), fixed-rate, 10-year loans are available in the high 4 percent to low 5 percent rates. Simply put, interest rates at this level can make marginal acquisitions look a great deal—better than they may actually be. Are we as an industry selling self-storage facilities or large amounts of real estate “lipstick” to make the product look better than it really is?
The second leg is the recovery that has taken place in the self-storage sector. Over the past three years (beginning in 2010, after the “crash” in the fall of 2008 with the demise of Lehman Bros. Holdings Inc.), we’ve seen occupancies rise significantly. For the first time in more than five years, the industry can now raise rates fairly significantly without fear that it will cause a stampede of move-outs. This has dramatically increased revenue and net operating income (NOI) for well-managed self-storage facilities in strong markets.
Lack of New Construction
The third leg is the lack of any meaningful new construction of self-storage facilities over the past five years, thus allowing the existing overbuilt capacity created between 2004 and 2008 to be absorbed. This has permitted those overbuilt markets to fill and for storage owners to begin raising rents as demand has grown.
There simply has been no appetite from the lending community to make construction loans for self-storage. As a result, the pipeline of new product is very small, and that doesn’t look to change for at least several more years due to the normal construction-permit timeline.