State of the Industry 2001

Will self-storage's good fortune continue?

By Barry Morris

After a slow beginning, the 1990s became a decade of unprecedented prosperityfor the self-storage industry. New properties emerged in many markets, bringingwith them burgeoning consumer awareness and acceptance of the product. What wasonce the domain of mom-and-pop operators, with rudimentary buildings shoehornedinto remote industrial sites, has steadily evolved into a largelydeveloper-dominated business with modern, amenity-filled buildings in primeretail locations.

It's not all glitz and glamour, though. With the prosperity comes perpetualconcerns about oversaturation, occupancy rates, financing availability and otherissues. After years of growth, current indicators point toward a possibleslowdown, attributable to some or all of these factors and consistent with ageneral cooling of the U.S. economy.

By tapping the knowledge of some of the industry's most respected insiders,this article will examine the current state of self-storage and its outlook forthe new year. Whether you personally remain optimistic or tend to side withnaysayers, the following should provide a good cross-section of views for theself-storage industry's prospects in 2001.

The Recent Past

When the potential for money-making opportunities in the self-storageindustry became common knowledge in the mid-1980s, developers scrambled toreact. A building boom ensued, pushing capacity far beyond demand for theproduct. Brisk competition and low occupancy rates combined to producerock-bottom rental rates--a scenario operators found not conducive to meetingtheir mortgage obligations.

This industry-wide slump continued into the 1990s, with occupancies fallingto their lowest point in 1990-1991, and the industry itself hitting rock bottomfrom 1990-1992. Many facilities were repossessed by lenders, and property valuesfell from their peaks of the mid-'80s.

But consumer demand eventually grows to meet supply in real-estate businesscycles--and sure enough, by the middle of the '90s, things began to circle backtoward prosperity for the self-storage industry. Occupancy caught up with theabundant supply, while the nation's economy strengthened. Financing firmsloosened their tight reins, and full-scale construction began again.

As the new millennium dawns, the self-storage industry's big picture is stilla positive one. That's not to say, however, there aren't some potential bumps inthe road. Will these bumps turn into gigantic sinkholes that will send theindustry falling toward a repeat of the late '80s and early '90s? Probably not.But given this history, most in self-storage seem to be better prepared to dealwith whatever changes may come to the marketplace.

The Inside View

No two opinions of the industry's current state are exactly alike. Whilethere seems to be no concern about a return to the depths of a decade ago, thereare a wide variety of views about exactly how strong the self-storage businesswas in 2000, or how it will be in 2001. Like the markets themselves, opinionsare regionally driven.

"This past year has been very good--actually a better year than'99," says Maurice Pogoda of Farmington Hills, Mich.-based The PogodaCompanies. "In the areas where we are, the economy has been sizzling. We'veexperienced a continued building boom here that has helped the self-storagearena tremendously. We have so many areas in Michigan and the surrounding statesthat are doing so well, and it always helps self-storage when you have that kindof activity."

"There's more money in the economy now than there has been in a longtime," says R.K. Kliebenstein of Coast-To-Coast Storage, based in BocaRaton, Fla. "And in a healthy, vibrant economy, people have more disposableincome. They're spending more freely. For self-storage, as awareness of theproduct grows, more people are taking advantage of it. As long as the economystays healthy, even though we're experiencing a lot of growth in the sector interms of new development, we will continue to lease that space."

Others, such as Jon Reddick of Sentinel Systems Corp. in Lakewood, Colo.,enjoy continued good fortune--but with an asterisk of sorts. "Things arelooking better than ever--we just had the highest sales month in the history ofour company," says Reddick. "Part of that is due to the internationalmarket. We're starting to build a real strong foothold in Europe, as well asAustralia and New Zealand. I think the United States market is starting to slowdown a bit. Before, it was incredible. Everybody was building or doing a projectall the time, and I don't see that quite as much now. But on the internationalside of things, they're really starting to move. They're typically two or threeyears behind us with technology, so I think that's why. They're where we weretwo or three years ago."

But others, while not pushing the panic button, see things slightlydifferently. The wildly fluctuating stock market of the past few months, forexample, is creating a less-than-clear financial picture. "Probably one ofthe major issues that's going to come around in the next year is the lack offinancing that may be available to refinance facilities," says Mike McCuneof Denver-based Argus Self-Storage Sales Network. "We're recommending toall of our clients that if they have a financing event in the next two or threeyears, they should probably tend to it now as opposed to later, when thefinancing may be more difficult."

A common axiom used in the real-estate market--"location, location,location"--could also play a role in a possible downturn, says oneexecutive. "I see the industry starting to slow down, not because ofdesire, but because of quality sites not being available," says JimChiswell of Williamsville, N.Y.-based Chiswell & Associates. "Thebarriers to entry are increasing because the type of facility required toattract today's new customer, in my opinion, is much more of a retail site,requiring all the bells and whistles in terms of security, landscaping and easeof access. All these factors are obviously going to increase the per-square-footcost."

Economics 101: Supply and Demand

With the proliferation of new properties in many parts of the country, thequestion of overbuilding and saturation of particular markets is always alegitimate one. Many operators, especially those who came into the businessduring the mid-1990s boom, launched projects with little forethought aboutlocation or market demand. "I've had some concerns about overbuilding, andI would share that to an even greater degree now," Pogoda says. "Iknow of so many more facilities coming out of the ground this year and so manythat are site-plan approved and ready to go, where people are just lining uptheir financing."

Too often, according to Pogoda, overbuilding is the result of inexperienceddevelopers entering the industry. "A cry that I've been lamenting for yearsis that there are many novices trying to get into the business who don't dotheir homework," he says. "People are picking locations that aresubpar, and building facilities willy-nilly without seeing if the market needsthem."

Mel Holsinger of Tucson, Ariz.-based Executive Self Storage agrees there isan abundance of overbuilt markets. "There are still some markets that havesome opportunities, but I think those opportunities are closing very quickly asfar as new projects being supported by existing markets," he says.

The strongest markets for new development are currently in California, saysMike Burnam of StorageMart, a Columbia, Mo.-based facility operator withlocations in several major metropolitan areas. Conversely, Burnam sees acontinued weakening in Phoenix--which had been a strong market for manyyears--as well as in larger Texas markets such as Dallas and Houston. But evenwhen a market shows some promise, the realities of the marketplace often pose aproblem. "Austin markets are a bright spot," he says, "but rentalrates are so low it doesn't warrant additional new development except at thelower end of the spectrum."

Even when a developer does his homework and chooses a site most agree will bein demand, there's no guarantee it will happen overnight. "We have somemicro-market areas within communities that have seen, over the last severalyears, a great deal of new growth," Chiswell adds. "It's going to takeawhile for those areas to absorb that new space."

The abundance of newer properties not only creates excess capacity; some sayit also creates a sort of class structure among properties, potentially makingthe older ones less appealing to the consumer. "New facilities are beingbuilt in areas where one or two operators have had it all to themselves foryears, and their facilities--which are now 10 to 15 years old--have becomedog-eared and tired looking," says Chiswell. "In many cases theyhaven't spent the money to keep their facilities looking sharp. That way theybecome very susceptible to that new kid on the block or one of the nationalcompanies coming in with their new prototype facilities, which are veryretail-focused."

Development and Construction

To attract the increasingly discerning self-storage consumer, new propertiesmust offer the latest amenities and conveniences, such as automated security,bank-card and AFT payment options, and activity on the Internet. "There'sdefinitely more climate control, more amenities being built in--it's the trendthat has been continuing through the late '90s," says Pogoda."Cameras, individual door alarms--those kinds of amenities are much moreprevalent now than ever before."

But the shiny trimmings incorporated into new facilities don't alwaysovershadow older properties--at least not in areas served by Pogoda's company."Because the markets have been so strong, it hasn't seemed to have had anygreat effect," he says. "These newer facilities have added to themarket, but the older facilities are holding their own. When you have adownturn, the consumer, if he has a choice, is going to go to the nicer facilityrather than the older facility. But when he calls up, most facilities are full.Consumers are taking what they can get."

As previously mentioned, site availability is becoming a greater barrier toentry into the self-storage business. If land isn't completely unavailable, itsprice often necessitates multistory development. A solution to this dilemma forurban areas has become known as "in-fill" construction, wheredevelopers go into downtown neighborhoods and either convert existing buildingsinto self-storage or demolish a building and put up a new facility on the land.Kent Greenwald of CB Richard Ellis Inc.'s Phoenix office referred to projectscompleted by a leading self-storage operator in the Los Angeles area. "Whenyou look at the land price, you'd be astounded," he says. "But whenyou look at the rents they get and how fast they lease up, it'sunbelievable."

Acquisitions

For movement of existing properties, a consensus of brokers' opinionssuggests the market is leaning slightly toward sellers. "There's still anabundance of buyers in the marketplace," says McCune, "and there aremore sellers as well. Right now it's a pretty equitable balance, and it's hardto predict exactly what's going to happen; but if the financing dries up, Isuspect there will be a buildup of sellers as opposed to buyers."

Marcus & Millichap's Burt Gay adds, "From a broker's perspective,it's great--we're moving into equilibrium. Before, there were very few sellersand very many buyers. Now it's more balanced. Two years ago, because we had verylow interest rates, we had very high prices. Much of the smart money sold then.Now the sellers are a little bit nervous with the stock market being precarious,and are coming out of the woodwork and being more willing to sell than everbefore in the recent past."

After riding the wave of a seller's market, Dean Keller of Bancap SelfStorage Group Inc. predicts there will be fewer aggressive buyers in the newyear. "Right now we have far more buyers than we have properties availableto buy," Keller says. "So any institutional-grade property--a facilityof 40,000 square feet or above in a good metropolitan market area that'sreasonably filled and reasonably located--is going to have buyers. Yet theystill have return on investment requirements, so they're not willing to overpayfor things."

Greenwald says sellers aren't flocking to him simply because the marketfavors them. "It seems there are a number of self-storage operators who arenot really motivated to sell because they bought or developed their propertiesin the early '90s, and they've ridden the economic boom." He adds thatthere's much greater knowledge of the self-storage market now than there was 10years ago. "I receive one to two calls a week from buyers who are not inthe self-storage industry, but are terrifically motivated to buybuildings," he says. "But the majority of the self-storagetransactions are still going between experienced operators."

Financing

Because of the problems experienced by the industry in the past, lenders arefar more careful about what projects they finance. While this may make ittougher to acquire a loan in some cases, those with favorable business plans arestill largely successful.

"There are many aspects of the financing arena still on the upswing andvery positive for the industry," says Neal Gussis of Chicago-based BeaconRealty Capital. "A lot of fixed-rate mortgages are being offered in the low8s right now and, on a relative basis to historical benchmarks, that's stillvery good financing for this industry.

"There are more banks than ever before that understand self-storage andare willing to look at it either on a local or regional basis," Gussiscontinues. "Conduits, or secured-type lenders, are still offering fixed-and/or variable-rate mortgages. On the downside, there are fewer of thesecured-type lenders and their underwriting requirements are stricter thanbefore."

The picture painted by Argus' McCune is somewhat less optimistic. "Ithink we're seeing a constriction of development finance about to happen, whichis going to slow down the additional development of sites and new facilities inthe next year," he says. "The FDIC (Federal Deposit Insurance Corp.)is putting some pretty strong constraints on many of the banks, and hasidentified several areas as being overbuilt in terms of real estate in general,which will impact self-storage."

Since banks will often lump self-storage projects in with other real-estateendeavors, McCune says the chance of getting favorable treatment is reduced."With self-storage being kind of at the lowest rung of lending in thebanks, they're likely to lend on self-storage projects when they've got acustomer who builds shopping centers and things they're more likely to put theirreal-estate allocation toward."

Technology

The addition of even more technological enhancements is one trend that mostagree will continue indefinitely. Though incorporation of the Internet into theself-storage industry has perhaps not been as rapid as first anticipated, itspotential continues to develop.

"We keep talking about the Internet, but I haven't seen it make hugeinroads just yet," Pogoda says. "We advertise and have our listingsonline, but our tenant base from the Internet is miniscule at this point--withthe exception that it's a little bit larger for our locations near collegecampuses. So that would give you the indication that it's going to become biggerin the future.

"I can foresee a time when we can sign leases online because of the newact that was just passed by Congress allowing electronic signatures. I can seethat being advantageous in the future, but it has not yet been revolutionary inthis industry."

Some are more optimistic about the web. "The Internet is going tocontinue to play a vital role in this industry in selling your product to themarketplace," says Dave Cook of Tacoma, Wash.-based Tech-Fast MetalSystems. "It's going to be much more interactive as a part of e-business asopposed to simply a marketing tool. Convenience, speed and accessibility toinformation are going to help you stand out from your competitor. And that'swhat the industry has always been doing anyway--from building plain, rectangularboxes in an industrial site to an architecturally pleasing, multistory projectin a residential zone, you're providing convenience and services closer to theneeds of the consumer."

Other types of technology are also making an impact for Cook. "From theconstruction process side, we and others are pursuing technology as a means ofproviding a better-quality product to the marketplace faster," he says."Speed is a huge motivator from a development perspective, because theobligations are in place, and another day that goes by is another day of rentyou don't receive until you get open.

"We view technology as an absolute requirement to stay competitive andahead of the market. We need to push on that because the timeline is beingpulled from the other direction--zoning conditions, code requirements and thepermitting process are getting longer. You need to be pushing the speed of whatyou have under your control, because the things out of your control are takinglonger."

Management

Though owners of self-storage facilities may possess a world of knowledge andexperience, it's widely believed an individual facility is only as successful asits on-site manager. However, for some self-storage operations, finding andkeeping good management is a monumental struggle.

"Most of the really top-notch managers who have been around awhile areable to acquire the positions with companies that are offering higher pay,better benefits, etc.," says Holsinger of Executive Self-Storage. "Theindustry is still, in my opinion, lagging in terms of manager salaries and beingable to compensate employees for what they actually accomplish. It's no longerjust 'Let's hire an older couple that has a retirement income and let them becaretakers.' That age is gone. You need somebody who's aggressive in selling,intelligent in office procedures and has the common sense to help both thecustomer and the company."

Holsinger credits seminars offered by Inside Self-Storage, the SelfStorage Association and others for helping to fill the training void."There's still a large gap between trained and untrained managers, but Ithink that gap is slowly closing," he says. "The training isavailable, and I think now you're seeing a lot of people take advantage of it. Ithink our managers, overall, are much better than they were even three yearsago."

Niche Markets

When the term "niche" is used in the context of self-storage, itcan refer either to geography or market focus. Whatever the definition,"niche" is a word used with increasing frequency in the self-storagebusiness.

"The self-storage industry has always been a niche business, and it'sbecoming even more of a niche business now," says Greenwald, using thegeographical definition. "A number of years ago, I would hear owners saythey were drawing their tenants from up to a five-mile radius; and then probablythree or four years ago, we were looking more at a three-mile radius. But now,I've had a number of owner/operators tell me that they're drawing a majority oftheir tenants, when they're in a built-up area like Phoenix, Seattle orPortland, from within a two-mile niche."

Specialty-niche markets are also being pursued by self-storage operators.Legal documents, wine, fine art, antiques, classic automobiles and other itemsdemand storage space, and in many cases it isn't feasible or cost-effective forowners of these items to maintain or create their own storage facilities.Converting facilities to house such items often makes sense for enterprisingself-storage operators. To this end, Coast-To-Coast Storage has recentlylaunched a store repositioning product, offering a combination technology/storeimprovement package along with market and management information.

"I think there's more awareness that we need to increase our productbase in order to maintain the occupancies, and most of these kinds of thingsrequire some upgrading of our facilities," says Kliebenstein. "So itgoes hand in hand with repositioning a store. You need to find new horizontalmarkets to go after, whether it be wine storage, antique storage or whatever. Itis not my belief that the best way to compete with a state-of-the-art facilityis to lower your prices--that just doesn't make sense. An investment in yourassets will go a lot further than just lowering your prices. I think necessityhas been the mother of invention here. As folks look for new ways to createstorage opportunities, they become a little more industrious in going after newmarkets."

The Year Ahead

What the long-term future holds for the self-storage industry is onlyspeculation at this point. Though many factors point toward a slowdown, mostdownplay it and some dismiss the notion entirely.

"Self-storage is a great investment in the long run," says Bancap'sKeller. "It's stable, it's safe, it's got good returns that are fairlypredictable, and I think that's why you see a lot of stability and a lot of goodcash flow coming from the publicly traded REITs.

"It's going to continue to be a good market for owners andoperators," he adds, "but be careful of new development. All it takesis one brand-new, empty facility across the street from you to really have adramatic impact on your cash flow."

"I'm still very bullish on the future of the industry," saysChiswell. "It still represents, to me, one of the greatest entrepreneurialopportunities in America in terms of creating a small business that can generatethe kind of revenue our facilities can, and the kind of financial return to thatentrepreneur who is willing to venture forward."

A few are exercising caution, however. "Who knows what the stock marketwill be like going into 2001, but we sure appear to be in very precarioustimes," says Pogoda. "I think the combination of the potentialdownturn many of us have been expecting for years, and the tremendous increasein capacity ... well, it's just simple economics. Something has to give. Atleast in the markets I'm in, we appear to be at that point."

Finally, at least one insider is steadfastly convinced that anything canhappen, and therefore sees speculation as pointless. "The longer I'm inthis business, the more humble I'm getting," says Gay of Marcus &Millichap. "I can't even predict sometimes which of my own deals willcommand what kind of prices and which ones will close. So when I try to makeforecasts of what's going to happen in the market in general, I'm on eventhinner ice."