Over the last three years, the self-storage real estate market has been the best ever. Interest rates have remained low; lenders are aggressive; industry information is getting better; values have risen rapidly; net operating income (NOI) has grown; and large institutional investors are buying assets. All this positive energy and performance has supercharged the development cycle, pushing the industry toward uncharted territory.
Historically, self-storage value has had more to do with where the industry is in the real estate cycle and market sentiment than actual property performance. Most independent owners still appear to be selling primarily because of life events, with few deciding to capitalize on the current market. However, it’s also apparent that institutional investors are taking notice of market conditions and choosing to sell some or all of their holdings, while being disciplined with regard to acquisitions. Concerns about new supply and rising real estate taxes seem to be at the forefront of everyone’s mind.
The prosperity of the current cycle has lasted longer and gone further than anyone expected. While the value of self-storage investments slowed in 2017, demand has remained strong. We continue to see new supply come online at a higher rate than previous development cycles, reflecting a planned-to-start ratio in the range of 40 percent to more than 50 percent in some areas.
The effects of new supply will be even more impactful in 2018, reflecting multi-year lease-up of prior-year deliveries. It’s anyone’s guess as to when the market will officially tip into the downward trajectory, but all signs point to this occurring in the next one to five years. In my opinion, self-storage is past the peak of the current real estate cycle. New supply and changing market dynamics will have an impact on performance during the next few years. The good news is, as we move through the cycle, there will be new opportunities, ushering in the upswing of the next.
In the last decade, self-storage has evolved from a mom-and-pop investment class to a mainstream, institutional asset class. The industry weathered the Great Recession and is now reaping the benefits of strong market fundamentals. Heading into 2018, let’s examine some key trends that will continue throughout the year.
Industry growth. One significant factor that makes self-storage a better bet in the long run than many other real estate types is its customer base is growing faster than the population. There are two key drivers providing the industry with tremendous leverage. First, many Americans have still never used the product. It’s estimated that 50 percent of new tenants are using it for the first time; and in many areas, there’s still unmet demand. Second, after about five to eight years, many operators report that an increase in business—more than 50 percent—comes from repeat customers.
If you combine those two factors, it’s clear consumers are still learning how to use self-storage, and they’re using it repeatedly once they do. The point is this type of growth isn’t limited to population and job increases. It gets a boost from consumers moving up the learning curve as well as ongoing changes in America’s housing products.
New supply. Development activity from 2017 and 2018 will deliver meaningful new supply to almost every major market. This will undoubtedly influence submarket fundamentals where new properties are being built. It’s no surprise that the regions seeing the largest influx of new development are those that have enjoyed great population and job growth during the last two to four years. Markets such as Dallas; Denver; Austin, Texas; Portland, Ore.; Atlanta; San Jose; and Tampa and Orlando, Fla., are all seeing a massive amount of new product.
In general, lease-up of new properties appears to be in line with the traditional two- to four-year pace, but rental rates seem to be slipping, with new properties having to offer larger than expected discounts to maintain their pace. There’s always an exception to the market, and if you’re one of the lucky developers who’s achieving faster than expected lease-up at or above your pro forma rental rates, the grass has never looked greener.
Consolidation. Though industry consolidation will continue in 2018, it’ll stem from a larger buyer pool than ever. The usual suspects, such as the real estate investment trusts and private-equity firms, will continue to dominate the larger, trophy acquisitions. However, we’ll also see more purchases from non-brand names and private real estate investors, as many take the plunge and enter the self-storage industry.
Most consolidation will come from mid-sized owner/operators because they’re willing to look at secondary and tertiary markets and buy smaller assets to grow their portfolios. The adage, “The only thing better than owning one self-storage facility is owning two or three” remains true.
Third-party management. Property-management firms continue to improve and create value for their clients. Companies like CubeSmart, Extra Space Storage and others have paved the way for third-party management by pushing revenue as well as standardizing and refining operational processes. This has allowed the industry to lead all real estate sectors in performance over the last 10 years.
These techniques, processes and capabilities have now trickled down to privately owned management firms, which provide a professional, economical product to markets and properties that haven’t previously had access to third-party platforms. This segment of the business will continue to grow and add value to the industry.
Technology. Advancements in this area have really grabbed hold in the self-storage industry over the last several years. The use of Web-based operating systems, electronic leases, mobile apps, kiosks and other automation tools, energy-efficient operating devices, and innovations from digital marketing firms will continue to allow owners to refine their operations and grow profitability through expense reduction, revenue increases and data-driven efficiencies.
The outlook for the self-storage sector remains cautiously optimistic. While the U.S. economy continues to accelerate slightly and new supply comes online, the industry should hold strong. There will undoubtedly be pockets of slowdown, but overall, the market should grow modestly in 2018. While we don’t know how long this current peak in property valuations will last, we do know that owners who take proactive measures to keep their properties competitive will be in the best position to capitalize on opportunities or protect against a potential downturn.
Ben Vestal is president of the Argus Self Storage Sales Network, a national network of real estate brokers who specialize in self-storage. Argus provides brokerage, consulting and marketing services to self-storage buyers and sellers and operates SelfStorage.com, a marketing medium and information resource for facility owners. It also offers panel discussions in which brokers from around the country share their insights on self-storage market fundamentals and economic trends in their regions. To access recordings, visit www.argus-selfstorage.com/presentations.html. For more information, call 800.55.STORE; e-mail [email protected]