The last few years have been an extraordinary time for the self-storage business, and real estate experts agree now is a good time to buy, sell or refinance. Sounds good all the way around, right? Today’s low interest rates and strong fundamentals have made good deals even better, and the cash-on-cash returns are simply staggering for owners, buyers and sellers. Self-storage has truly become a respected, maturing competitor in the national real estate market.
We’ve all seen the comparison of the self-storage industry to other real estate sectors in recent years and, in short, the returns for self-storage are higher and the various risks are more moderate with one exception: the risk of overbuilding. The main reason is self-storage properties are all competing for the same customer, and we’re a more localized business than other real estate sectors.
The office, retail and industrial sectors can target specific customers, businesses, professionals and industries, such as medical-office buildings, research and development industrial complexes, and destination retail. It has been proven that the customers of these real estate products will travel great distances. Conversely, all self-storage customers are basically looking for the same product—a friendly, clean, safe and dry place to store their personal treasures. In almost every case where occupancies and rents have declined, there’s strong evidence that overbuilding is a substantial contributor to this undesirable market condition.
When it comes to overbuilding, nobody wants to do it. While some builders claim the “devil made me do it,” most really don’t want to develop a poorly performing project. So why do they proceed? While a few are just stubborn beyond any rational considerations, most are thoughtful and concerned about how they invest their money. Thus, when they investigate an opportunity to develop in a specific market, they seek the best information to justify their decision.
The problem is most self-storage information is either unavailable or unreliable. Most other real estate industries (i.e., office, hotels, industrial, retail) have well-developed and reliable information on the state of their markets. For example, in any city in America, an office developer can learn the average rents, concessions, planned projects and occupancies by building quality and submarket in about a half a day. This information is largely developed by empirical data (actual data) as opposed to statistically developed data (small amounts of surveyed data projected to a much larger conclusion).
Every other major real estate sector has information based on substantial, comprehensive empirical data. Unfortunately, the bulk of information in the self-storage industry is still statistically developed.
For the most part, self-storage professionals have to rely on statistical projections which, at best, provide limited information about the largest markets and none about submarkets or secondary markets. Information about submarkets is the most valuable for owners and developers. The lack of quality submarket information leaves most developers flying blind when making the decision to build a self-storage project. Some may say it's a great site, but they should also ask if it's a good market.
For many complex reasons, including the availability of construction money, entrepreneurial developers are rarely scared off by this lack of information; in some cases, they actually seem to be encouraged by it. However, many of the very large self-storage operators seem to have a good handle on what’s going on in a specific market and are developing and buying properties with the significant strategic advantage of having empirical (actual) data. Without access to this type of information, the entrepreneurial developer doesn’t have the ability to make the right decision and might potentially build a project that could ruin an entire market for a long time.
Dangers of Overbuilding
All over the country, we see building and development cranking up in every place where zoning can be achieved, although nowhere near the levels of the early to mid 90s. Construction loans no longer appear to be a constraint on building. So let me describe a hypothetical market and show you what can happen to a “good” market when the tipping point of demand has been reached.