Will the Boom Continue?
By Cecile Blaine
They say hindsight is 20/20. That's why we must look to the past in order to anticipate the future. It is especially true in gauging the health of the self-storage industry. Since self-storage is a real-estate function, it is subject to its business cycles, with few people actually agreeing on what part of the cycle we are in at any particular moment. However, we can look around us, to the past and to the present to analyze where the industry is heading.
Since industry experts began recording statistics in the early '80s, we have been able to look at the development of the self-storage industry and identify cycles, trends, growth spurts, stable periods and downturns with accuracy. What is confusing is that the various economic indicators of the industry aren't always in sync with each other; they may even contradict each other, with one area waiting to catch up to another. For example, new construction may be brisk, while rental rates and occupancy are leveling off or even dropping--as is the case with the current business cycle. That's why determining the health of the self-storage industry can really only be an exercise in educated guesswork--that is, until the year is behind us, and we have numbers, figures and hindsight on our side.
Self-storage was officially born in the mid-'70s in the southern states, areas of the country teaming with multifamily housing, roving populations and few basements to store belongings. Mainstream developers discovered self-storage as an investment in the mid-'80s. The word on the street was that self-storage was tantamount to easy money; cheap land, easy development, low overhead, few staff members and little management added up to excellent earnings in the eyes of developers. The result was a building boom that lasted several years with a number of newly converted self-storage gurus.
By the late '80s, however, a profitable, fledgling industry was turning into a bloated, overbuilt one with high vacancies and mortgage payments and sagging rents. It continued into the early '90s, with the market finally hitting its lowest point ever from 1990 to 1992, with many facilities across the country repossessed by lending institutions and the RTC.
Consumer demand eventually grows to meet supply in real-estate business cycles, as it did by the middle of this decade, and the market began to stabilize. The advent of REITs has led to increased sophistication, a wealth of financing from Wall Street investors, expansion of the typical facility and a hot market for existing facilities.
Let's look at where the industry is today.
According to the 1997-98 Self-Storage Almanac, national rental rates for 1997 dipped about 3 percent from 88.3 percent in 1996 to 85.1 percent in 1997. Nevertheless, over a 10-year period, the Almanac's 1997 rates are still nearly 5 percentage points higher than 1988 figures of 80.4 percent.
When looking at that set of statistics only, it is easy to assume the industry is on the downside of the business cycle, but many would disagree. Dave Cook, president of Tech-Fast of Tacoma, Wash., is one of those people. "I think that's a reflection of the amount of inventory that's been brought into the market," Cook says. "You can look at isolated communities and areas of the country that...are overdeveloped, saturated. (However), development will shift to other regions until that inventory can be occupied."
Still others say that the industry has overemphasized the importance of occupancy. "That's the sacred cow of self-storage," says Mike Burnam of Storage Trust Realty, based in Columbia, Mo. "We've got to keep our facilities full. Why?"
There are few national indicators of rental rates in this industry. According to the Self-Storage Almanac, rents on five out of eight unit sizes fell in 1997 compared to 1996. Presented with these statistics, the chief operating officer of one of the largest self-storage real estate investment trusts (REITs) is moved only by disbelief. "For a fact, I know they have not," argues Mike Burnam of Storage Trust Realty of Columbia, Mo. "Ours have gone up 8 percent," from $7.01 per square foot in the third quarter of 1996 to $7.69 in 1997.
Maurice Pogoda has a different perspective. As the president of The Pogoda Group in Farmington Hills, Mich., he says the many projects planned for his market this year are bound to push rental rates down. "I don't see us being able to get anything but measly rent increases this year--if at all," says Pogoda, who currently manages 19 facilities encompassing 1.2 million square feet. "We eked out what we could last year, and we still have projects in the mid '90s. But there's a palpable sense that it's not as strong as it was in 1997. It wasn't a dramatic difference, but as new projects come on line, it siphons off a little bit here and there."
Availability of Financing
One of the most prominent changes in self-storage in recent years is the development of REITs and the resulting insurgence of money available for financing.
Buster Owens of Rabco, the Ocoee, Fla.-based self-storage engineering and construction firm, says the amount of money available for construction is unprecedented. "The availability of money in the market to do construction is higher than it ever has been," he says. However, it isn't just REITs that are flush with cash. Management companies are finding other sources for financing, such as pension funds, Owens says.
Pogoda has also seen the financing landscape change significantly in the 10 years he's been in business. "Financing has changed so dramatically over the last two years," he says. "We've got financiers fighting over who can give the lowest rates and the best interest."
The question then arises "How much is enough?" Too much money in the economy can fuel inflation and too much in the industry can fuel a recession. Tech-Fast's Cook doesn't worry about the abundance of funds in the system. "I don't feel that it is out of control," he says. "I don't feel that financing is so available that (lending) is done without good judgment. The due diligence that (our customers) go through is certainly prudent and something I think is relatively sound. Financing is not free. It is available, but you still have to show where that's a reasonable risk. Having gone through the collapse of the savings-and-loan industry, that's not something that people have ignored and forgotten."
Not everyone is so optimistic. "Instead of 80 percent loan-to-values, I'd still prefer to see 70 percent loan-to-value, where people have to know their business and they have to be willing to put their money where their mouth is," Pogoda says. As he sees it, the current system "lets people open up facilities that haven't done their homework."
Storage Trust's Burnam sees only one direction for the self-storage industry: up. As good values in the market are getting few and far between, the company is beefing up its plans for new construction in 1998. Burnam says $10 million is budgeted for in-house construction and $10 million to $20 million for joint ventures.
Cook says the amount of business his company is enjoying reflects a still-rising level of new construction. In fact, all of his barometers for business--inquiries, quotes, responses to advertising and existing business--indicate that good times are ahead. "The level of activity is still strong," he says.
Rabco's Owens, whose customers include some of the larger management companies and REITs, sees a similarly sunny outlook for the industry. The types of facilities he is building on the East Coast are generally larger than in the past. "A lot of that is attributed to all of the REIT money in the market," says Owens. "The availability of money in the market to do construction is higher than it ever has been."
Site Selection/Facility Design
The process of site selection has gone through its own cycle over the years, strongly influenced by REIT activity and the increased legitimacy of the industry. When the industry first started, developers often chose sites that were out of the way, irregularly shaped or in some way unattractive. They could be located in an industrial complex or have very limited street access with most of the facility out of view. By purchasing these relatively inexpensive, odd pieces of land, developers could enjoy profits sooner. According to Owens, the REITs have upped the ante over the years--building on land that is much more expensive, much more attractive to other developers. "What they are doing is paying premium prices for class-A sites," says Owens. "Therein lies the big difference.
"It's not uncommon for Shurgard to pay $795,000 or $800,000 for a four-acre piece," Owens continues. "It's not top dollar, but it's class-A exposure."
As a result, the definition of a "good site" has changed, says Cook. "The difficulty these days is to find that affordable site that can provide a return on their investment in a location where there is demand--at a reasonable price," he explains.
The type of site that larger developers are looking for hasn't changed, according to Burnam. "I still want my site to be in between Burger King and Taco Bell with McDonald's across the street, WalMart on the corner and a car dealership on the other corner," he says.
Facilities themselves have become larger, by most accounts. One of the most recent differences is that, as a rule, developers would build two-story facilities on expensive land in urban settings. Now, some say, REITs will put up a two-story facility almost anywhere.
Economies of scale and more attention to efficiency by the larger management companies may also explain the larger size, since those larger facilities offer the kinds of revenues that will pay for the property sooner than a small one. "You can spread your costs over more square feet," says Burnam. "Therefore, you can afford to pay for that location."
But what about individual developers? They don't have the bankrolls that the REITs do. Pogoda says he has seen site selection go full circle. "When I first got into the business, a lot of facilities were being built in what we most all agree are not great locations," says Pogoda, whose clients are mainly smaller independents. "Then for a while, the pros were stepping in and building in the A-1 locations. It's almost like the '80s all over again. We are seeing in our markets so many people who want to get in on this self-storage thing that they've heard so much about. So, they are building in locations that I personally would not build in. So, it's almost come full circle--but only in a negative way."
With the growing competition from REITs, which everyone admits has only made the industry stronger and more respectable, smaller independent management companies must pay more attention to operations. "If you are an individual developer, I still believe in the need for phasing," growing only when the immediate demand has been satisfied, says Owens. He also suggests more emphasis on curb appeal and meeting toe to toe with the big guys on amenities, such as climate control, security features and other extras.
"Bells and whistles are going to go a long way," he adds.
One shortcut REITs can take in showing their investors an immediate profit--avoiding the construction phase altogether-- is by acquiring facilities. And they have been buying them up in droves. Storage Trust, for example, has more than $100 million budgeted for acquisitions in 1998.
"They have to show earnings immediately, especially with the Wall Street money," Owens says. "They can't just spend this money just to spend it. It's got to pan out, because if it starts hurting their earnings, they'll probably take a beating on the open market."
With the wealth of funds available for purchasing facilities, it has been a seller's market for the past several years. As an example, U-Haul has acquired approximately 150 facilities since 1992, according to Carlos Vizcarra, vice president of storage and corporate moves. The company has no specific budget for acquisitions for 1998, because as Vizcarra says, "We avoid restricting our budget so as not to limit growth opportunity. We will look at any size property or portfolio anywhere in the U.S. and Canada."
Where Do We Go From Here?
Is national saturation and recession just around the corner for the self-storage industry? There are a few who see the current financing situation as a sign of future overbuilding and a repeat of the late '80s and early '90s.
"Suddenly, what was learned from the S&L crisis and the real-estate depression of the early '90s has been forgotten in 1997-98," says Pogoda. "It is very disconcerting. We'll probably bottom out a couple of years from now, where average occupancy rates will be in the low- to mid-'80s."
Some recognize a downturn, but are not particularly alarmed by it. "I don't think that's a concern," says Cook. "I think that's a natural cycle."
But the view from the top is clearly grand, with larger management companies and REITs not aware of any end to the good times. U-Haul's Vizcarra says, "The health of the self-storage industry is contingent on continuing economic gains, and the future looks bright."