By Rachel Adams
A decade ago, there were few cities without one or more new self-storage projects underway. But as more facilities were built, consumer demand was met. Then came a recession that dried up construction bank loans and left blueprints collecting dust.
Today, ground-up development of self-storage facilities has given way to consolidation, with the real estate investment trusts (REITs) and larger, private companies leading the charge. Rather than building new, these companies have turned to up-and-running facilities to save time and collect the existing cash flow already being generated.
"Its faster to acquire than to build new properties," notes Marc Boorstein, a principal of MJ Partners Real Estate Services, a real estate brokerage and investment-banking company in Chicago. "The long lead time to get new developments permitted, built and then leased up to stabilization has partially caused development for REITs to virtually cease. Additionally, the difficulty in obtaining construction financing for large-scale programs of new development has limited new construction."
Consolidation has also accelerated over the past two years as more properties have become available and banks began to lend again. "In 2011, public REITs purchased approximately $1.6 billion of self-storage properties as compared to about $400 million the year before," Boorstein says.
An established tenant base and cash flow are a natural draw of acquisitions, says Jason Allen, co-owner of Performance Self Storage Group, a Redwood City, Calif.-based self-storage brokerage firm. "When you look at the cost to build compared to the sales prices and price per square foot paid on the most recent transactions, it only makes sense to buy a pre-existing facility with built-in cash flow on day one.
Consolidation and the Private Operator
While consolidation has picked up, its impact has only greatly affected operators in the top metropolitan areas, real estate experts say. This means the industry is still primarily in the hands of small-business owners, which are typically single-site operators.
"Its important to remind ourselves that the majority of consolidation weve witnessed thus far has involved what those within the industry refer to as class-A facilities, and more than 80 percent of those facilities are within one of the nations top 50 largest markets," says Charles Ray Wilson, founder and principal of Self Storage Data Services and a partner in the Self Storage Industry Group (SSIG) of Cushman & Wakefield, an Irvine, Calif.-based commercial real estate firm. "What that means is for the majority of smaller, private operators, consolidation is not a threat."
Jim Chiswell, a self-storage consultant and president of Chiswell & Associates LLC, agrees the biggest impact has been in the top metropolitan markets. "In most major cities, the 'big boys' have commanding market positions. However, when you get out to the second- and third-ring suburban markets, and virtually all rural markets across the United States, the realization is the top 100 operators still command less than 50 percent overall market share.
While many small, private operators fear the increased competition and possible changes the REITs may bring to the industry, these companies also bring lower capital rates, which raises facility values, not only for them but for all operators.
"Consolidation in general is good for the industry," says Chris Sonne, the executive managing director of Cushman & Wakefield's SSIG. "It may seem scary to a small operator, but transaction demand drives down capital rates, which raises values. Capital interest by both lenders and equity helps all operators, not just the large ones."
Consolidation brings other benefits to smaller operators as well, such as improved technologies, higher rates and standardization of the quality of products and services offered. It can also lead to less competition for consumers, says Nicholas Malagisi, national director of self-storage for Sperry Van Ness International and managing director of Sperry Van Ness/Commercial Realty, a commercial real estate brokerage firm in Buffalo, N.Y.
"This may translate into increased market share by the operator, who can further his economies of scale that are so prevalent in our industry and reduce his operating costs per property or per square feet," Malagisi notes. "While these economies of scale should reduce his operating expenses, this does not necessarily translate into reduced prices for the consumer."
While small, private operators still maintain their role as heavyweights in the industry, REITs are bringing new aspects to the game, like more advanced technologies and nearly unlimited marketing resources. Experts agree small operators must stay ahead of the curve to compete with larger companies.
Doing so may be a challenge for some smaller operators, says Kevin White, director of business development for Virtus Real Estate Capital in Austin. "The result of consolidation will be that it makes it much more difficult for the single-site operators to compete. They dont have the Internet-marketing capabilities or revenue-management programs to compete with the large operators."
To come out on top, operators in busy markets need to be smart about their advertising and marketing, especially online, Malagisi says. "The Internet was originally thought to be the great equalizer in that a small business could create a website to advertise its products or services to compete against the larger companies. We now know the large operators dominate the Internet by paying mega dollars to have their company names on page."
Wilson has no fear for small operators who are up for the challenge. "There will always be room for the single-site operator who can stay competitive," he says.
Is New Construction on the Horizon?
Self-storage real estate experts agree that while acquisition is still the strongest trend in the industry, some companies may be gearing up for development. This is in part because the self-storage industry is at the bottom of the real estate cycle, moving from recovery into expansion, Wilson says.
At this point, several factors will come into play: The demand for storage will increase, economic vacancies will continue to decline, rental rates will start increasing, capital rates will decline, and investors will become more interested, Wilson says. "We are at or nearing that point in the cycle, and some owners are starting to gear up for development. For now however, there are still opportunities for greater yields thought acquisition vs. new construction."
Charles (Chico) LeClaire, senior vice president of investments and senior director of the National Self-Storage Group for Marcus & Millichap Real Estate Investment Services, a commercial real estate brokerage firm based in Denver, agrees new construction may be around the corner. "If the trends continue, we're going to see more new construction, and that will add new players into the market. The REITs will continue to buy, and developers will start to build again."
In fact, some development has already begun in select markets, according to Ben Vestal, president of the Argus Self Storage Sales Network, a national network of commercial real estate brokers specializing in self-storage real estate. "This will continue as long as construction financing continues to improve and self-storage continues to produce high returns, he says.
Will Consolidation Continue?
Although development may be on the horizon, acquisition is still the most efficient way for the REITs and larger companies to expand, and self-storage experts expect this trend to continue well into 2013. "Abundant capital from private equity funds, private operators and public companies, combined with low costs of capital for acquisitions should maintain the recent acquisition trend," Boorstein says.
In fact, operators should expect industry consolidation to continue for the next few years, says Stephen Grossman, senior vice president of NAI National Self Storage Investment Group, a real estate brokerage firm in Newport Beach, Calif. "Commercial mortgages are maturing, and owners need to choose between refinancing or selling. If market values have decreased and appraisals are weak, the owner may be compelled to add equity to a refinance. This could be enough motivation to the owner to consider a sale."
While this may mean fewer smaller operators, it doesnt mean an end to self-storage as we know it. "There may be fewer single-site operators as consolidation increases, but more than 80 percent of self-storage is small operators. So the trend will continue, but few will feel it," Sonne says.
As the industry matures, the best will survive and the weaker will be either bought or out-competed, Vestal says. Within the self-storage industry, there are some very competent and qualified small operators who will fare just fine over the long run."