By Aaron Swerdlin
Due to current circumstances surrounding the capital markets, there are tens of millions of dollars of equity looking for a home in the self-storage space. A joint venture can be a great way to leverage equity, benefitting both the equity and operating partners.
Commercial real estate transaction volume is very healthy, and transactions in core markets are at very high levels against the five-year average. Almost five years of sustained low interest rates has a lot to do with the obvious conviction behind the steady volume. The current market is also benefiting from a plethora of capital on the equity side.
The low interest-rate environment permeates the investment world. A general lack of meaningful yield available in lower-risk vehicles forces all investors to get creative and expand their universe. No-risk investors, if there is such a thing, generally focus on a portfolio of Treasury bonds. But with near-zero percent yield on short-duration bonds and going out as far as 30 years for a less than 4 percent yield, the lowest-risk, fixed-income investors have broadened their field of vision. Every time an investor class broadens its risk tolerance, supply-an-demand fundamentals compress yield across the spectrum, and those seeking higher yield are displaced to a higher point on the risk curve.
This is one of the principal drivers behind the Federal Reserve’s bond-buying program. By strategically buying around $85 billion of bonds every month, it's able to strategically displace yields. Theoretically, what the Fed chooses to buy each month is at a higher price (lower yield) than what the “next guy in line” is willing to pay, so he has to go elsewhere for that yield. Not only does that compress the yield on the bonds the Fed purchases, it sends that next guy to a different duration bond or maybe even a different asset class.
This is why the Fed’s decision regarding when and by how much to taper its bond-buying program is so critical to pricing. By beginning to remove the artificial compression, the interest-rate market will slowly settle into a supply-and-demand pricing model that’s conditioned solely on its own merit.
As the Fed tapers its monthly bond buying to zero, the pricing across all assets classes and the full spectrum of risk will become more fluid and arguably more predictable. Certainly, some of the taper is priced into the market. But the speed with which the Fed reaches zero will have everything to do with how large swings in pricing toggle and the volatility with which those swings occur.
Bringing all this back to commercial real estate, and specifically self-storage, the volume of equity looking for yield has an all-time high amount desirous of landing in the self-storage space. Undeniably, self-storage transaction volume is at very elevated levels relative to historical averages. The most active buyers by volume have been the real estate investment trusts (REITs). But the most active by number of transactions have been the privately held companies.
Driven by those seeking yield, the performance of the self-storage public equity market has been remarkable. It has reinforced that the industry is a valid asset class among investment real estate; that operationally it’s extremely resilient against a recessionary environment; and comparative operations against other product types gives the nod to self-storage every time.
This has enabled the REITs to finance much of the sector’s transaction volume through equity placements, debt placements and preferred and perpetual preferred equity offerings. With ample demand for equity, they will be able to continue to finance their activities from a wide swath of resources. In some cases, they’ve joint ventured with private equity firms to acquire portfolios.