Self-Storage Facilities Gain New Respect

By Aziz Khan

Six shortyears ago, many owners of self-storage facilities felt like the Rodney Dangerfields ofcommercial real estate. Stigmatized as owners of the physically unattractive,sub-investment-grade developments no one wanted next door, they were in search of greaterrespect, both from the surrounding communities who enacted tough zoning laws to limit newdevelopment and from lenders and investors who gravitated toward more glamorous propertytypes.

Fast-forward to 1999, however, and these owners face improved prospects. Consumerdemand for self-storage space is still growing steadily in many markets. What's more, thetremendous influx of investment capital to the commercial real-estate market has created abuyer's market for fixed-rate loans as low as 7 percent to 8 percent. Though most lendersstill favor owners and investors seeking to refinance existing debt or finance newacquisitions, loans for new construction are becoming easier to obtain as a more diverse,better informed group of lending institutions casts its eye on the self-storage market.From the local banks and savings and loans that kept the industry afloat during moreturbulent times to today's portfolio investors, conduits and private capital-investmentfunds, lenders are finally awakening to the tremendous upside this market can offer.

These favorable conditions give veteran owners several powerful options. They canrefinance their current debt and lock in a fixed-rate loan, a strategy that enables themto draw out a significant amount of equity, reduce debt costs and increase bottom-linecash flow. Alternatively, those seeking an exit strategy can take advantage of thevoracious appetites REITs currently have for established, well-performing properties. Withlow interest rates and cap rates on their way down, properties are selling quickly atprices current owners never imagined possible. Owners can maximize their selling price byworking with an experienced broker who understands how to package self-storage propertiesto both REITs and individual investors.

Steady Transformation

Just how attractive has the self-storage market become to lenders? The industry hasadmittedly attracted fewer lenders than other commercial properties because many stillview these facilities as higher-risk operations. Further, many balk at themanagement-intensive nature of this business, citing high turnover rates and collectiondynamics reminiscent of the hotel industry. For example, the average rental period forresidential self-storage customers, who represent 76 percent of business volume, is just10 months--21.3 months for commercial customers, according to the 1997-1998 Self-StorageAlmanac. The same source lists the 1997 average occupancy rate for the 26,272facilities nationwide at 85.12 percent.

Lenders with experience in this market, however, see a different picture. They focustheir attention on established facilities with proven track records, experiencedmanagement and higher local profiles because they boast occupancy rates closer to 90percent. Experienced lenders also note that the average cap rate of 10.64 percent, basedon data compiled by the 1997-1998 Self-Storage Almanac for 172 selected facilitiesnationwide, declined from the 10.77 percent reported a year earlier. Their conclusion isobvious: Providing capital for refinancing and acquisition is not as risky as someinvestment professionals think.

Powerful Change Agents

Irrespective of its position today, though, the self-storage industry can anticipate abright future because it will benefit from a combination of favorable market anddemographic forces, significant product changes and the industry consolidation that willcontinue as long as REITs compete furiously to acquire new properties.

The aging of the baby-boom generation and shifting population trends are fueling demandfor self-storage facilities. The growing seniors population points to increased storagedemand as they downsize to smaller residences and migrate to lifestyle-driven destinationssuch as Florida, Arizona and California. Furthermore, shifting migration trends willcontinue to create new pockets of demand as new residents flock to popular sunbeltlocations and chase the stable employment opportunities found in the rust belt markets. InTempe, Ariz., for example, Heller Real Estate Finance recently provided a first-mortgageloan to refinance a Class "A" facility that was constructed in 1995. Though anadditional self-storage facility is scheduled for development in the vicinity, demand inthe area is likely to grow much faster than supply. During 1996, 1,600 new multifamilyhousing units were developed within a two- to four-mile radius of the property, andanother 2,000 units came on-line in 1997. A number of single-family housing subdivisionsare also under development, most lacking the built-in storage space that basements or fullgarages provide.

The self-storage industry is also strengthening its appeal by introducing new productsthat respond to evolving consumer demand. Today's new facilities offer a broader choice ofrental dimensions and amenities, such as computerized accounting and security systems,climate control, and computerized lighting and utilities that help hold down operatingcosts and rental rates. A case in point is a facility Heller recently refinanced inPhoenix, which offers a comprehensive security system that includes video surveillance,climate control and spaces for boats and RVs.

The third significant trend, consolidation, may cause some growing pains over the shortterm, but promises to further stabilize and solidify the market over the long term.Short-term consolidation of ownership has brought with it a flurry of new construction aswell-capitalized companies jockey for position, and occupancy rates may suffer in certainmarkets as the 400 new facilities currently under construction come online. In the longterm, however, consolidation will drive up total quality. When REITs first targeted theself-storage markets in the early 1990s, few facilities qualified as investment-gradeproperties. In today's consolidated landscape, almost half of the self-storage propertiesnationwide meet this standard. In effect, REITs have not only established higher levels ofvaluation, they have ushered in a new competitive standard for both professional facilitymanagement and for marketing as well. Independent self-storage facilities, for example,have begun to form marketing co-ops that allow them to purchase the large quantities ofadvertising space they need to increase name recognition.

A New Level of Respect

In the self-storage arena, the presence of conduits and the growing number of lenderswho understand this market have lessened--but not eliminated--the struggles owners face tosecure financing, especially if they seek construction loans. But as REITs continue towork their magic--driving up values and driving down cap rates--and as the real-estatecommunity becomes more attuned to the solid underlying fundamentals this property typeoffers, owners and investors may see signs of even greater respect and a more favorablefinancing environment in the years ahead.

Aziz Khan, director of capital markets at Heller Real Estate Finance, is productmanager for the manufactured-home and self-storage markets. As a national lender to thosemarkets, Heller offers a broad range of debt and equity-loan products, includingfixed-rate conduit loans, through its Heller Express Program. Mr. Khan can be reached at(312) 441-7945.