This month, our roundtable of real estate experts discusses the self-storage market in the Southeast United States. Our panel members includes William Barnhill, Omega Properties Inc., Mobile, Ala.; Dale C. Eisenman, Midcoast Properties Inc., Hilton Head Island, S.C.; Stuart LaGroue, also of Omega Properties; Grady Riggs, Long & Foster Real Estate, Fairfax, Va.; Stephen Rigl, Orion Commercial Ltd. Corp., Miami, Fla.; and W. Frost Weaver, Weaver Realty Group, Jacksonville, Fla.
1. Are secondary markets (i.e., smaller, second-tier cities) in your territory a good choice for self-storage?
Eisenman: Smaller markets can be productive for self-storage but the same principles apply as in larger markets. Investors should carefully review the local market to estimate demand and calculate supply. A small community may offer less supply per household than a metro area, but the demand may also be lower as measured in square feet and/or the price tenants are willing to pay for storage. If there is demand for storage and the rents justify the investment, the property can be successful regardless of the city’s size.
LaGroue: In some instances, small and second-tier cities are a good choice because many of the larger, primary markets have become saturated with storage. However, this does not necessarily mean one should rush into these potential markets without first doing an analysis. If a smaller market appears to have fewer units and properties, there may very well be a reason such as low demand or household income. Also, in many smaller markets, there tend to be fewer barriers to entry for future competitors. As we all know, the days of build and they will come are long gone. That’s why it’s imperative to conduct a feasibility study.
Riggs: Many second-tier cities in the mid-Atlantic region are becoming attractive to big businesses and expanding federal government agencies due to their relative lower cost of land, cost of construction, housing and better transportation facilities to and from major cities. As a result, many of these smaller locales like Winchester, Va., are seeing tremendous growth. The Base Realignment and Consolidation will impact many second-tier cities in the coming months in Maryland and Virginia with increased population growth and thousands of new jobs. With this growth comes a demand for storage.
Rigl: Prices have lost some of the firmness accumulated in the past few years and have leveled off, especially in smaller outlying markets. There is overbuilding in certain markets so the demand side must be duly considered. Hurricane Wilma a few years back had a perversely positive impact on self-storage occupancy in south Florida, driving it to high levels. Some of that has now bled off creating some vacancy in certain markets.
Weaver: Much northern Florida activity has been in the secondary markets. These markets generally present good investment opportunities for the private investor because the properties are typically smaller and more affordable. Additionally, the major self-storage operators are usually not present, and until the recent housing slump, these markets have been growing faster on a percentage basis than the urban market. I believe this trend will continue.
2. Given the unsettled investment markets, how are buyers and sellers reacting?
Barnhill: Many sellers still have higher expectations on pricing than rental rates are able to support. Buyers are still available but want a realistic cap rate. Money is still available from local banks but a lack of conduit loans has slowed down acquisitions somewhat.
Eisenman: Both buyers and sellers are exercising more caution in this market because of the uncertainty in the economy and credit/capital markets. Buyers are less certain what their borrowing costs will be when a proposed transaction closes; many are including a “fudge factor” in their underwriting to absorb unexpected shifts in rates. Sellers are recognizing this and weighing it as competing offers are considered.
Riggs: Either the numbers work or not. I haven’t seen any panicked buyers or sellers. What I have seen are newer facilities in suburban areas of large cities like Baltimore, Richmond and Washington. Pro formas based on new or planned housing developments are not seeing the lease-up they anticipated because many of these developments are not selling as anticipated. This is because most of the housing credit problems are in the major cities and their hyper-expanding suburbs and exurbs.
Rigl: Some institutional buyers are hunting good deals, especially with those owners adversely impacted by the credit crunch. Some development strategies are being reworked by integrated property owners holding a variety of property types, possibly to jettison undeveloped parcels initially slated for storage to others with better liquidity positions.
Weaver: Even though the economy is unstable, storage properties that have stabilized income continue to be an attractive investment. We have had some recent inquiries from potential investors who are considering moving dollars from the stock market. I believe this trend will continue.
3. How are the local lenders for self-storage reacting to the “credit crunch”?
Barnhill: Local lenders are gradually becoming more cautious in their underwriting. Floating rate construction loans are at reasonable rates. Acquisition loans are available but with higher equity requirements.
Eisenman: Banks that lend short-term base lending decisions primarily on the credit and character of the borrower as opposed to the underlying real estate. They are offering attractive short-term rates due to recent rate reductions but they are taking a closer look at the underlying project’s viability. Long-term lenders recognize that the CMBS market will not be robust for years to come, and more traditional lenders such as life companies will apply lower loan-to-value ratios and more strict underwriting criteria than has been enjoyed in the CMBS market.
Riggs: I think lenders who understand the self-storage business still see this (now more than ever) as a very attractive investment class that is not directly affected by the ups and downs of the investment market. Interest rates are very good and lenders are willing to do deals. The big advantage is no shortage of buyers exists in this region, which keeps values up. In my area, it’s still a seller’s market.
Rigl: Local lenders are expressing interest in quality properties with a proven ability for success. CMBS loans are difficult or unavailable to most single-asset property owners.
Weaver: The larger national banks have restricted financing for storage and other investment properties, but the community banks are still seeking loans. They are actively pursuing lending opportunities, but underwriting is more stringent and property cash flow must demonstrate that it can support the loan. There is also more scrutiny of the potential borrower/guarantor in addition to the property cash flow. They are focusing on the “global” cash flow of the borrower from all of his investments.
4. What impact have credit problems had on cap rates?
Barnhill: Cap rates in the Gulf region have inched up about 20 basis points for high-quality properties and 40 to 50 basis points for B- and C-quality properties.
Eisenman: Borrowing costs for a buyer are as much a cost to be considered as property taxes and payroll. Most investors seek a target return for the cash invested and if long-term lending rates rise, buyers will pay more in interest payments, reducing the cash flow of an investment. Understandably, if an investor is going to earn less on an investment, the amount willing to be paid for that investment will be less whether it is self-storage, a retail center or other income-producing asset. If rental rates and occupancy soften, further pressure will be put on cap rates.
Riggs: Cap rates are still fairly steady. We’re still a seller’s market.
Rigl: Cap rates are ratcheting up as an indirect result of the CMBS-lending sources exiting the market. Life companies are in the market still, but at different spreads and other terms than that of CMBS lenders of 2007.
Weaver: Regarding interest rates, depending on the credit and experience of the borrower, rates are at prime plus .5 percent to prime plus 1.5 percent. Cap rates on actual sales are generally in the 8 percent range even for stabilized properties. Investors are looking for a higher margin on their investment return because of risk factors and the economy; for example, potential for decline in occupancy due to housing slump and tenants making other arrangements to reduce out-of-pocket rent dollars. In addition, the decline in short-term rates has not been reflected in long-term rates, because of lack of conduit financing and the increased spread from other long-term lending sources.
Michael L. McCune is president of the Argus Self Storage Sales Network, a self-storage real estate brokerage and development company based in Denver. Argus also operates www.selfstorage.com, a marketing medium for owners in the self-storage industry. For more information, call 800.55.STORE.