State of the Industry ReportA look into the year 2000

State of the Industry Report
A look into the year 2000

By Teri L. Lanza

"I never think of the future. It comes soon enough." ~Albert Einstein

That it does.

A year ago, Inside Self-Storage conferred with industry experts--crooned to the crystal ball, so to speak--in an attempt to catch a glimpse of the year ahead. Well, that year is complete, and here we are chasing insights, not only for the upcoming year, but for a whole new era. Now that we're barely recovering from another prosperous and promising spell, the question sitting on everyone's lips is, "How long can it all last?" Do the next 12 months indicate a strict diet of "more of the same," or will the dreaded downturn at long last be evidenced?

It isn't about stark metal buildings anymore, and everyone knows this. It's no great surprise that "storage" has made it's way onto more and more households' and business' monthly list of expenditures. What is surprising, according to industry gurus, is that good fortune has come to roost for as long as it has, and so uncompromisingly. What began as a difficult and uncertain decade has evolved into an epoch of unfettered growth for developers, owners and vendors alike.

Here, we'll examine the current state of the industry and where some of its more seasoned insiders believe it to be headed in 2000. Consider it your opportunity to look behind the curtain. The future may arrive soon enough, but there's certainly no harm in anticipation.

Let's Recap

The state of self-storage now as opposed to 10 years ago is a world of difference, and gratefully so. "The dramatic changes we've seen are in how the industry has grown up," says Maurice Pogoda of Farmington Hills, Mich.-based The Pogoda Companies. "The big things that have happened have been in the real-estate cycle. In the early '90s, things were just plain awful, due to the Savings & Loan crisis and the credit crunch. There was an overabundance of storage space, and buildings just weren't filling."

By the mid-'90s, things had begun to improve, with occupancies rising and owners being able to raise rents. There was also a resurgence of capital at this time. "The development that had been entirely stifled in the early '90s went into high gear," says Phoenix-based CB Richard Ellis' Kent Greenwald. "It started out a bit slowly, but by the time we got to '95 or '96, the REITS were also on their spending sprees, which made for a very active market." Rates began to skyrocket, occupancies were high, and the real-estate investment trusts were offering outrageous prices to buy properties--prices that, as Pogoda points out, were not sustainable by anyone but a REIT with its lower cost of capital and desire to build marketshare.

There was another element entering the mix at this point as well: A tremendous number of developers who had been damaged in the Savings & Loan crisis and had never built self-storage before stumbled into what they discovered to be a very easy industry to enter. "Self-storage was much easier than constructing the office building or complete shopping center that they might have built before," Greenwald explains. Development began to boom.

No Time Like the Present

Since then, development has remained steady throughout the country, to the point where overbuilding has become an issue in several areas. There are still some hot markets, however, primarily in major metropolitan areas with dense populations, areas such as Washington, D.C., Los Angeles, San Jose and San Francisco, Calif., according to Greenwald.

Dean Keller of Bancap Self Storage Group in Rancho Santa Margarita, Calif., agrees, although he, too, acknowledges the impending possibility of saturation. "Right now there are more buyers in this industry than ever before and, unfortunately, at least out on the West Coast, there aren't as many sellers as we'd like to see," he says. "Everybody in the business is doing better than they've ever done before, so unless there's some unique circumstance, they have no motivation to sell."

That doesn't mean there isn't danger ahead. In a market like San Jose, where there were 4 million square feet of storage space, everyone was full and had waiting lists. It was one of the strongest markets in the country, according to Keller. But now, with another 2 million square feet of space either constructed or in the pipeline, everyone's getting a tad nervous. "Some of the new properties that have opened are filling slower than expected. Things are getting a little bit scarier," he admits.

Mel Holsinger of Executive Self Storage in Tucson, Ariz., shares his experience. "The Arizona market seems to have stabilized, but we're still surprised at the number of projects proposed or that are under construction, because it seems that the occupancy of projects--at least in Arizona--has been bound in certain markets and stabilized in others. I don't see occupancies rising significantly. And, obviously, if more projects are brought on board, they're going to decrease. This is also making for some interesting pricing situations."

Mike McCune of The Argus Self Storage Real Estate Network in Denver says, "We're seeing dramatic saturation in some markets, modest saturation in others and, in some areas, hardly any. Unfortunately, however, almost bigger than the problem is that we don't know how big the problem is. All we have is anecdotal information on specific markets," he says. "We don't know what the dimensions of the market are, and you look at some of the numbers and you still see rents going up and occupancies only being slightly impacted, but you don't know how good those numbers are either, how representative they are."

Dave Cook of Tacoma, Wash.-based Tech-Fast Metal Systems notes that aside from the potential danger of saturation, cost has become another issue. "The dynamic from our perspective is that construction is just more expensive. The cost of development is significantly higher and continues to go up--you're talking about the cost of land, code application, growth management ... That makes it more difficult for the self-storage developer and manager out there to get an appropriate return on his investment and manage his debt correctly," he says.

The result of this? Developers are having to be more discerning in their site selection. "They're completing more comprehensive market studies and paying greater attention to the demand/supply relationship of storage within submarkets," Greenwald points out. "The business has also become much more niche oriented. Rather than looking at the well-publicized saturation of a major market area, developers are looking at small submarkets or niches within the metropolitan area that can justify a storage property."

The Question of Demand

With the cost of development rising and site availability becoming more of a challenge, developers must address the question of demand--can it support the product? According to Holsinger, demand is increasing, though not significantly. "Every year there is more demand for the product, and right now it seems the supply is at least equivalent to that demand in a lot of markets. As the demographics change, I see more and more demand in the Northeast, particularly in your more dense markets like New Jersey, Pennsylvania and New York. There are still a lot of opportunities, a lot of markets that are still underserved," he says.

Steve Cooper of Digitech International, based in Asheville, N.C., agrees that a greater portion of the general population are using storage facilities. "It's a cultural as well as a demographic thing," he explains. "As the facilities being built are more modern and sophisticated, they're attracting a greater clientele. When you put in features like security systems, etc., you keep your commercial users happy as well, and attract a lot more professionals."

But the demand isn't strictly for more self-storage--it's for a different kind of product. "Every new facility is certainly more attractive, more oriented on technology, more competitive than existing facilities," says Bancap's Keller. "So all things being equal, I'm seeing new properties coming on the market being able to generate higher rental rates. Even in terms of getting the loans and appraisals done on these projects, it's a fair bet to say that a new property will be able to get above-market rental rates as compared to existing facilities."

Jim Chiswell of Williamsville, N.Y.-based Chiswell & Associates adds, "Based upon my consulting work across the country, I'm seeing a growing demand for space. Average unit sizes are getting bigger, and despite the comments to the contrary, the majority of projects are still being built with manager apartments (zoning permitting)." This indicates an enduring interest in the product, as well as a confidence in its longevity.

However, while there is certainly greater demand for self-storage and the perception of the self-storage product has changed in the eyes of the public, that does not necessarily mean that it has become solidified enough to withstand another recession, should it occur. According to Pogoda, "We've become a bit sanguine about how good things are, but we're going to have to wait it out through the next recession--whenever that comes about--to see whether storage is as commonplace as we think it is," he says. "One of the concerns that we should all have is not to be too complacent about how storage is 'trendy.' When the economy is as strong as it is, people throw money about much easier. I'm not a believer that this is a recession-proof industry. I've not witnessed it, and my experience has been just the opposite."

Maturation or Saturation? Now What?

Although McCune firmly believes self-storage to be looking at a year of great uncertainty--based upon the industry's dependence on the general economy--most of our experts indicated the upcoming year will not witness any dramatic changes, particularly not a significant downturn or slowdown in development. "They've been talking about a downturn in this industry for three years now, but the only thing we see is that it keeps getting stronger," says David Reddick, president of Sentinel Systems Corp. in Lakewood, Colo. "We've just had our best year yet, and that's partly because of our product and service, but partly because the industry is strong. I don't see anything slowing down in the near term."

Digitech's Cooper agrees. "If you listen to the futurists who have been speaking to our industry at various tradeshows and conferences, they are--for the most part--speaking in contradiction to the Wall Street prognosticators who say we're going to have a downturn and inflation is going to go crazy again. The industry speakers are saying that, primarily because of the Baby Boomers, we're going to see a real bull market for the next five to seven years." While there was little indication that most experts believe the industry's good fortune will hold out that long, the overall sense is that it will at least carry us through the next year.

"Economic conditions are still favorable for the development of self-storage," says U-Haul International's Carlos Vizcarra. "The major barrier to entry that we see is just the restrictive zoning statutes in many municipalities, but other than that, the economy is still supportive." This does not mean, however, there won't be a certain amount of stabilization of the rate of development. Tech-Fast's Cook does predict a leveling off. "More and more, the dynamics of financing and overall economic health for the country is what dictates our ability to continue to develop," he says. "We have not seen any indication filtered through our efforts that there is waning interest for the product from the public, and I would have to say, in general, that over the next year we'll see a level of development activity comparable to recent years. But the signs are out there--we've grown into an industry that can be impacted by general economic forces out of our control.

"The forecast is for stock-market performance, availability of financing at reasonable rates, fear of inflation, etc. If we begin to see any significant stock-market dips or high consumer-debt building (which is kind of what is occurring at the moment)--some of those signs start to chip away at the wonderful growth that we've had. I think forecasters would say that just one of those things happening can be enough to push us into a slow-down or recessionary time period. They're saying that things will calm down in a year, possibly two--but it'll be a slowdown and not anything dramatic. I don't see anybody just turning off the spigot. Nothing's going to just stop. Will they level out? They certainly will."

Regardless of what may be the most realistic prediction, there is still a lot of optimism out there. "Absolutely we are looking at another good year," asserts Cooper. "I think it's going to be an astounding year." And according to Chiswell, "I think 2000 will continue to be an excellent year for our industry. There are a number of projects already under construction that are coming online. These new projects, like the ones opened over the past several years, are going to have an impact on the older projects. The new, state-of-the-art projects will continue to erode the marketshare of many first- and second-generation projects."

Construction Trends

So let's talk about that for a minute. If what Chiswell and Keller tell us are true, and the newer, more sophisticated properties will eventually supplant the older buildings, where is development being driven? What about the higher cost of construction and limited site availability? How will those things change the landscape of development over the upcoming year?

"I personally believe that new building is going to slow down, for a lot of reasons," Pogoda explains. "First, the cost of capital is going up. Second, the cost of vacant land has skyrocketed. Land that we'd pay $2 a foot for a few years ago is now $5 or $6 a foot, and rental rates in self-storage have not increased that much--not enough to warrant paying those kinds of prices." A good point. But that doesn't necessarily translate into a slowdown of development altogether. Builders are now exploring new alternatives. "People who are interested in moving forward are looking at every avenue," Pogoda says. This perspective is one that seems to be shared across the board.

"Self-storage is becoming a true retail-type of business, and builders are spending a lot more money on the land, a lot more per square foot than they used to," says Buster Owens of Ocoee, Fla.-based RabCo Corp. "So now we're seeing larger projects on smaller sites, which dictates going up instead of out. Multistory building is extremely popular. I would say 80 percent of all projects that we're doing have at least one two-story on them. And they can afford to do that because of climate-control self-storage being more in demand. It's easy to build up when you can climatize that space and get the kind of returns you want," he says.

Cook from Tech-Fast adds, "Site availability is more difficult these days. You're spending more money on a more difficult site and having to spend more to develop it. There's no question that this fact will drive more multistory building, and it has. It's unique that we do a project that doesn't involve multistory or climate-control services." In addition to more multistory and climate-control development, the state of the current markets is also driving more retrofits.

"The trend we're seeing in construction itself is what some people are calling 'in-fill' construction, where developers go back into urban neighborhoods and convert buildings," says Digitech's Cooper. Keller expands: "Since people haven't been able to buy new property, they've been looking to develop older property; and since it's more urban areas than rural that people want to build in--at least in California--you're forced to build multistory because of land costs. To go in and do an in-fill project or conversion can be a very smart move."

Fancy, Schmancy

"A study that we completed in the last year was of self-storage properties developed over the past 36 months," Greenwald shares. "And we've found that the well-located, better-designed properties were experiencing lease-ups significantly above average. A basic business premise is that in a market that becomes saturated, the only way to increase your profitability is through market segmentation or differentiation." As a result, developers are now looking at ways to differentiate their product in order to realize a higher net income.

What exactly does that involve? A greater emphasis on amenities, technology and design. Developers are being forced to pay greater attention to detail and aesthetics, but whether that is a product of zoning requirements, sophistication of the marketplace or customer demand--or a combination of the three--is inconclusive. "Certainly developers are building nicer and more attractive facilities these days, and the local ordinances certainly have something to do with that," says Sentinel's Reddick, "but I think what really drives this trend is that building more attractive sites helps to draw business."

One of the biggest trends we've seen in self-storage recently has been a maturation of the types of services offered. "Self-storage has become a more mature product, a better-run product now that technology and security are married together in management," says Cook. "Aesthetic treatments are also important now, primarily because of zoning. If you look at growth management, whether it's managed or whether it's just a perceived understanding of a community to a developer, there's a message given that a project must look a certain way."

RabCo's Owens expands, pointing out that the greater emphasis on aesthetics relates to self-storage as it enters a more retail environment. "We're now seeing a lot of nice facades, Victorian looks, windows, different types of crown-molding features. There are a lot more architectural demands than there have been in the past. A lot of it is due to Planning and Zoning. Some of it is being dictated by the municipalities or approval boards--if you pay big dollars for expensive ground in a retail area, they don't want it to have an industrial look. But some of it is driven by the owners' requirements. They want their project to have the curb appeal that will separate them from their competitors."

Is all of this really necessary? Well, the jury is still out on that. There are those, like Pogoda, who are not convinced. "There is much more attention to architectural detail today, true; and a lot of that is forced on us. But the bottom line is that--contrary to what people may think--the average tenant doesn't know the difference. They want a nice, clean, attractive facility, but it doesn't have to be the Taj Majal. I think the trend that will continue, however, is one for more amenities, such as climate control. That's where the demand is."

Argus' McCune agrees that some owners will tell you that the fancy accoutrements make a facility easier to rent. However, he also points out the effect this could ultimately generate. "What's going to happen is that if you get into a price war, the lowest common denominator sets the price. So the guy who hasn't spent as much money is going to set the price. Some consumers are simply driven by price--their perception of value is different. I'm not saying the amenities aren't important--they are. But there is a certain segment of the market that is not willing to pay for them. The concept of high-quality self-storage is more involved in the owner's mind than in that of the general public. Particularly in bad times."

Talking Tech

One trend that everyone agrees will persist as the year progresses is the addition of more technological features, including management software, security, payment options and use of the Internet. "What automation and technology give you is convenience and service and efficiency," says Cook. "Whether it's development, construction, or operations and management, any way that you can use technology to provide a quicker path to better service is a benefit. And the pressure will be there in the next year for you to automate and use technology that will make things more customer-friendly, faster."

According to U-Haul's Vizcarra, "Technology is really playing the key role in helping to differentiate the storage product. We're seeing a lot more climate-control storage, enhanced security and other features, such as credit-card or debit payments, etc." Reddick, who anticipates greater use of special features such as electronic funds transfer, agrees, "Someone who is aware of the technology to help manage and protect his facility is getting a leg up on his competitor because they are upgrading what they offer, enhancing their salability to the public. What we see in the upcoming year is a lot of upgrades."

Let's not forget to mention the ubiquitous presence of the World Wide Web and its effect on this industry. "Obviously, the Internet is impacting everybody's business already," says Holsinger. "Marketing strategies are going to change simply because technology has changed. And where, in the past, we relied on the Yellow Pages--and it's still an important venue--it's use is somewhat decreasing as more and more people use the Internet to access information."

Chiswell also stresses the importance of this indispensable cyber-tool. "I think we'll see an even greater impact of the Internet on our industry in the next several years. The snowball gently rolling down the hill is starting to gain momentum already in the buying and selling of cars and homes. Our industry will not be far behind. I envision the day in the next five to 10 years that new unit rentals, billing, collections and marketing will all be primarily focused on a facility's Web site."

"In the next two or three years, the Internet capabilities and the like are going to explode," adds Pogoda. "It's clear that's where things are heading. There's just no doubt about it."

It's All About the Money, Honey

In the end, questions regarding market saturation and site availability, multistory building, climate control, architectural pomp or amenities will all be moot if the bottom line is not addressed: financing. Without funding, it is not a question of "If you build it, they will come." You just won't be able to build it. So do the experts foresee any significant changes in the availability of funds? Not particularly, though there is some skepticism as to how long the lending institutions will remain comfortable with overbuilt markets.

According to Cooper, the financial markets on which self-storage will hold up and continue to be stable for some time. Holsinger, on the other hand, predicts a change. "Lenders will eventually become aware of the real economic impact all the new development will have on long-term projects. It's easy to get financing when you have no competition within three or four miles of a major metropolitan city. But take Tucson, for example: Now, there are almost 80 properties where, five years ago, there were 55. The lenders putting money into these markets are going to get nervous because the stores are not going to absorb the square footage as was projected. It usually takes lending institutions a couple of years to catch up to what's really going on," he says.

Chiswell remains hopeful. "I think it may get a bit harder to find construction loans as the year goes on, but I still see strong indicators for the first half of 2000. Because of the growth we have seen in the past five years, it's more critical than ever for developers to do their due- diligence homework on site selection, however. The days are long gone when justification for a project was, 'I already own the land. How hard can it be?'"

McCune believes long-term financing is going to become much more difficult to obtain and banks will be frightened off. "The banks are still doing all of the development loans, and if they begin to realize that there's not good take-out money, they're going to begin to tighten up, and that will slow development down. But for now, the pipeline is full." He also feels there are fewer players than there were a year ago, which will result in consequences for people attempting to refinance or wanting to sell properties, for example. "That's going to have an impact on the general liquidity of the real estate," he says.

Something else to consider is interest rates, which are presently rising; and according to Pogoda, if they continue to do so, it will prevent people like him from continuing to develop. "My cost of capital would be too high, and then the cycle starts. When that effect might come about, I have no idea, but I have to assume rates are going up and investors' needs for return are going to be greater than before. I have to adjust my projections. Others should be doing the same, and if they aren't, I think they're foolish."

Are we painting a grim picture? Not really--just a realistic one. But experts like Greenwald are interpreting tighter financing and interest-rate increases as mere speedbumps, put into place to ensure the market doesn't overbuild as in previous cycles. Lenders are being more selective, and builders are required to conduct more comprehensive feasibility studies, but this should, ultimately, be for the greater good of the industry.

In the End

Do we know, yet, what to expect from the self-storage industry in this supposed "new millennium," or will we, as some have predicted, stumble about in uncertainty and hope for the best? All signs point to continued success, as long as a certain degree of caution is maintained. Overall, it should be business as usual.

"The industry is so strong right now, so solid. I surely don't see any major changes coming this year," Pogoda admits. "I foresee the trends continuing for some building, though I think it will slow down. I see the trend continuing for more climate-controlled space and more amenities at sites. I see it becoming increasingly expensive and difficult to find the kind of self-storage locations in the more developed markets that the pros really want to find. This is going to force people to be more creative and explore other alternatives. But the industry is fundamentally very sound. Short of there being something catastrophic with the interest rates or the economy, why expect things to change dramatically?"

Others are more skeptical. "I think we're looking at a year of great uncertainty," says McCune. "It's dependent upon the general economy. Any kind of blip will have a significant impact, and I think that overbuilding in some markets is also going to have an effect. And then I think financing is one of the biggest uncertainties, as it impacts the liquidity of the marketplace as well as value."

All things considered, experts are optimistic about what lays in wait for business this year. "I still feel that the development and ownership of self-storage facilities is one of the best entrepreneurial opportunities, not only in the United States, but around the world," says Chiswell. "I'm still excited about our industry and its long-term future."

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