By Michael Hoffman

Positive signs in the U.S. economy could mean improvement in the self-storage sector in 2012. Low interest rates, unemployment and strategic home foreclosures could mean a higher demand for storage space in some areas, and unique opportunities are developing on the investment side of the business.

The latter part of 2011 brought a steady stream of positive readings for the U.S. economy and commercial real estate. The data points failed to shatter any recovery records, but they reaffirmed that the economy and commercial real estate sector are headed in a positive direction.
Underlying data on jobs, core retail sales and corporate profit beat expectations by a margin large enough to substantially reduce recession fears:

Self-Storage Operations Strengthened

By the end of the third quarter of 2011, self-storage operations in the Northeast began to improve after two quarters of losses. Occupancy increased to 89.7 percent in the third quarter of 2011, an increase of 2.7 percent on a year-over-year basis. Assets in Boston and the New York-Newark metropolitan statistic area (MSA) were among the most sought-after in the region. Boston occupancies increased 300 basis points to 90.8 percent by the third quarter, while New York-Newark occupancies jumped 120 basis points to 90 percent. Rents increased 2 percent in the New York-Newark region to $1.55 a foot.

Occupancies stabilized across the Midwest, with East North Centrals rate increasing 20 basis points to 82.2 percent and West North Central jumping 10 basis points to 83.6 percent. Ohio markets boasted some of the best fundamentals: Occupancies in both Cincinnati and Cleveland rose 1.8 percent to 80 percent and 84 percent, respectively. Cincinnati rents also jumped 1.4 percent to 75 cents per square foot.

In the South, self-storage occupancy rates increased 10 basis points to an even 80 percent. Atlanta and Orlando, Fla., were standout performers in the Southeast as occupancies in both metros jumped 3 percent to 80 percent by the end of the third quarter. Meanwhile, Atlanta rental rates shot up 2.7 percent to 75 cents a square foot.

The San Francisco Bay Area boasts some of the strongest self-storage fundamentals in the nation, trailing close behind the New York-Newark MSA. Occupancy accelerated 5.9 percent to 85.9 percent in San Francisco, while the entire western regions occupancy dropped a nominal 10 basis points to 83.9 percent.

More Improvement on the Horizon?

Bolstered by generations-low interest rates, the self-storage investment sector should continue to improve in 2012. Areas with high barriers to entry, such as Boston, New Jersey, New York and San Francisco, are expected to stage a strong performance this year. Muted construction in these major metros will allow operators to burn concessions and raise rents to pre-recession levels.

The southern states will see steady population growth as residents migrate to Texas, which has created 50 percent of the nations new jobs since the onset of the recovery. As a result, demand for self-storage space in most of the Lone Star states metros will improve.

Meanwhile, in the West, elevated unemployment and strategic home foreclosures will encourage residents to downsize into apartments, buttressing the need for self-storage space and lengthening average stays. Formerly overheated housing markets such as the Inland Empire, Las Vegas and Phoenix will benefit from this trend through 2012.

However, when the tax break afforded to homeowners who short sale or foreclose as part of the Mortgage Debt Relief Act of 2007 expires, fewer residents will walk away from underwater mortgages. This will add clarity to home prices and slow the migration to apartments. This could, in turn, temporarily soften self-storage demand.

Unique Opportunities Arise

In the self-storage investment arena, the real estate investment trusts (REITs) will remain bullish on discounted class-A and -B properties in primary markets, while smaller, private buyers will shift toward secondary and tertiary areas. The Sunbelt will garner the most attention this year, as a wave of real estate-owned properties emerge in overbuilt markets such as California and Florida.

Well-capitalized institutions that can achieve efficiency through economies of scale will acquire distressed assets for value-add plays. These investors will lease up the properties to achieve maximum occupancy levels and refinance the portfolio within a two-year period to leverage additional acquisitions.

As competition intensifies for upper-tier assets, cap rates will continue to compress in the second half, averaging in the mid-7 percent range. Private buyers, meanwhile, will target markets in Georgia, Michigan and Utah, paying cash for highly vacant class-B and -C properties for potential upside. Assets in these areas will trade below replacement costs and can produce returns in the low 10 percent range.

The guarded optimism for a better year for the economy and self-storage market should give way to more cheer when it comes to investing in commercial real estate. Private investors have become more active, and more capital is flowing to class-B assets and secondary markets in light of rapid tightening of yields in the upper tier of the market. The current prospects of investing in a hard asset that is set to improve along with an expanding economy, even at a moderate pace, with generations-low cost of debt locked in for five to seven years and competitive cash flow yields, point to a unique commercial real estate investment window.

Michael Hoffman is the first vice president and national director of the Marcus & Millichap Real Estate Investment Services National Self-Storage Group. The company specializes in commercial real estate investments and has more than 1,200 professionals in offices nationwide. To reach Hoffman, call 303.328.200; e-mail  [email protected] .