Inside Self-Storage Magazine 07/2004: The New Face of Overbuilding

The New Face of Overbuilding

By Michael L. McCune

Over the last 30 years, self-storage overbuilding has been an issue much talked about, even worried about; but so far, it hasn’t become a significant problem. The reigning consensus is if there is overbuilding in an area, time will cure the problem, and all will be well again. Many believe that since overbuilding has not yet become a problem, it won’t. But the reality is it may indeed become a challenge on a larger scale, and time may not be the cure-all for this difficult situation.

Overbuilding is really an imbalance of supply and demand. If we understand these two elements of our business, we can evaluate the state of overbuilding in a market. However, information on these topics is practically nonexistent in our industry. While some sources purport to know how many total square feet of storage space exist in the United States (supply), many people doubt their validity because the numbers usually rely on assumptions, computations and limited surveys.

The quantifiable numbers relating to demand are equally suspect. For example, demand is usually expressed in number of square feet per capita. But the unresolved issue is why some markets are overbuilt at 4 square feet per person, and other markets thrive at 8 square feet per capita.

In case you didn’t know, the Self Storage Association is so concerned about this long-neglected void of information that it has several projects in the works to improve the situation. While this will be helpful in the future, at present, it leaves us with little or no reliable quantitative data through which to understand the all-important balance between supply and demand.

In the past, the major source of self-storage demand was “pent up.” That is, in the beginning, no one used storage, though there were a lot of people who needed it. To better understand this concept, think about cell phones. When they first became available, no one had one. Then everybody bought one. Thus, it was easy for the market to grow 50 percent per year. The same story holds true for self-storage—it just took longer for people to recognize their need for the product. And, unlike cell phones, self-storage isn’t programmed to break every two years.

Also, there isn’t much of a replacement market in self-storage. It is clear everyone who wants a storage unit probably lives or works within 5 miles of a facility and has for several years. In addition, some studies indicate as much as 25 percent of the national population is using self-storage at any given time. In the past, this factor was the most significant impetus to growth.

The demand for self-storage was also “uneducated” in that people didn’t know much about various uses for the product. As they started to use it for one purpose, they slowly discovered others. I like to call this the learning-curve factor. No one truly knows the effect this factor has had on total self-storage demand, but common sense tells us it is a lot less today than in the past. Certainly, most people are now familiar with self-storage and its multitude of uses.

Pricing is another issue that has an impact on demand. Early selfstorage projects were constructed economically on relatively inexpensive land. As the industry matured and zoning boards got involved, facilities became more sophisticated. This, of course, cost more—sometimes a lot more—and, thus, rental rates had to increase. When prices increase and demand goes down, this is what economists call price “elasticity.” No one has successfully measured self-storage price elasticity, but we know it is there.

For example, let’s say someone decides to throw away the old living-room set he was saving for his kids’ future apartment when he figures out the total rent on his self-storage unit will actually cost twice what a new set of furniture would. In some markets, a 10-by-10 unit can equal 5 percent of the per capita income (remember, this is pretax income). In light of this, a family may think twice about spending a significant chunk of its budget or, at least, reconsider how long to leave items in storage.

The last issue impacting self-storage demand is the density increase of the market in which a project is built. Many facilities are in partially developed suburban areas. As the area fills in with houses or businesses, demand in that specific market will increase at a much faster rate than for the greater surrounding city. As the area matures and fills, growth will slow, declining until all of the available land is gone, even though the city may still be growing.

This works fine for existing facilities, as long as none of the infill development is competing self-storage. The net result is our industry, like a lot of other real estate, now depends on population increase for most of its net growth. It appears the growth accelerators discussed above are having less impact on the market in general. Clearly, there are areas that will still be very attractive to self-storage developers and continued ownership; but extraordinary growth in demand cannot be guaranteed everywhere, or even in most places.

Again, actual data on new supply is not very substantial. We have the Dodge Reports, which show some of the new development, but not all; and we don’t have a very good idea how much information we are missing. There are, however, several things that indicate supply is likely to increase:

• Loans for development are readily available and cheap, at their lowest rates in 40 years.
• Project sizes are getting bigger—in part, to offset high land costs.
• Lots of “little” projects are also being built.
• There is a huge demand for self-storage investments.
• Everyone thinks they are an expert in self-storage development.

Somewhat offsetting the increase in supply is the lack of available land for development. But even this has a dark side in that if a builder has to accept a sub-par location, he can charge lower rent and compete on price.

Depending on the circumstances of a particular market, many new projects may face slower demand than those developed in the past. As growth slows, lease up of new projects will also; and operators will likely be forced to compete for market share based on lower rents. Unfortunately, overbuilding affects not only a new property, but all existing facilities in an area. New facilities tend to be larger, have all the latest amenities, and be very tough competition in every way, including price.

Let me describe a hypothetical market and show you what can happen to a “good” market when demand is limited by population growth. Our market has five properties of 50,000 square feet each, and the average occupancy rate is 88 percent. This translates into a total supply of 250,000 square feet and actual demand of 220,000 square feet. A new developer builds an 85,000- square-foot facility in the area. Supply is now up to 335,000 square feet, but demand is still at 220,000, because the builder didn’t bring any new renters.

Now, if we have hit the point where demand is no longer exponential but only grows with the population, we have a fairly serious problem on our hands. Let’s take a look at how fast population grows in this country. According to appraisal source Integra Realty Resources, top population growth for a metropolitan statistical area (MSA) in 2003 was 3.39 percent (Naples, Fla.). However, the top 10 MSAs only had to grow a minimum of 2.21 percent. The average MSA grew 1.38 percent. If our hypothetical market grows at the highest possible rate, it would still take 10 years for it to return to its previous occupancy level of 88 percent. If our market is just average, that same recovery would take a whopping 23.5 years!

If self-storage demand in a market has slowed to the rate of population growth or even just approach that level, we are in for some strange times in the self-storage business. It may be time to review your building plans and asset-holding decisions.

Michael L. McCune has been actively involved in commercial real estate throughout the United States for more than 20 years. Since 1984, he has been owner and president of Argus Real Estate Inc., a real estate consulting, brokerage and development company based in Denver. In 1994, he created the Argus Self Storage Real Estate Network, now the nation’s largest network of independent commercial real estate brokers dedicated to buying and selling selfstorage facilities. For more information, call 800.55.STORE or visit www.selfstorage.com.