As of February 2009, large Canadian financial institutions were continuing to pull out of self-storage, leaving little hope for their return. The big banks and lending institutions on which owners and operators relied were no longer lending to this asset class.
Consequently, as mortgages begin reaching their renewal dates, money may not be available. Owners with mortgages coming due in the near term may have to rethink their game plan. Finding financing will become more difficult, and some owners may even need additional capital to replace all or some of their financing. If they cannot find the needed capital, they may be forced to sell.
A few large self-storage institutions and portfolios will still be able to acquire financing; however, it will not come without added cost. An example of the impending pressure of refinancing is Instorage Real Estate Investment Trust's mortgage-renewal deal. The company recently refinanced a $29.2 million loan on which it had previously paid less than 6 percent interest.
In the renewal, the company was only able to secure $25 million at a 9.65 percent interest rate for three years. This means that in addition to paying an increase of approximately 4 percent interest, Instorage also had to come up with $4.2 million in equity. The company is now paying approximately 650,000 more interest annually for less money. If these sites were 100 percent occupied, Instorage would have to increase rent $2.65 per square foot to maintain its bottom line.
Instorage’s mortgage refinancing is a good example of what the future may hold for many self-storage owners. Looking at the number of mortgages possibly coming up for renewal, the prospects are astonishing.
For the sake of argument, let’s say the Canadian self-storage market is a $5 billion industry, and 50 percent of that is leveraged with most mortgages on five-year loans. This would mean $500 million will be coming to term in the next year. If we do not have the resources to renew $500 million, the industry will see a portion of that amount hitting the market in one year. The most the Canadian market has seen exchanged in a year is $300 to $350 million, 65 percent of which was likely financed.
What Happens Next
The potential impact could result in a disheartening situation, one owners and operators should be aware of and thinking about. However, it may not be a devastating situation for everyone.
Although interesting and trying times lie ahead, there will be unique opportunities that arise. Our industry still appears to be in a relatively good position if we consider there are still many underserved markets. Although there are definitely markets that are overbuilt or have significant product still in lease-up, many also have considerable room to grow.
One positive aspect of the industry’s financial state is there is a large number of owners who are underleveraged, having little to no debt on their facilities. Being underleveraged in boom times is generally perceived as negative; however, it may prove to be a positive situation in our current economy. Since acquiring financing has always been more difficult in the storage-asset class, people with low financing are now in great shape.
The downside is this situation will hurt the industry’s bottom line. Even if the industry is 50 percent leveraged, interest rates are still going up, weakening cash flow. It won’t break people in good positions, but it will hurt. The owners who will be hurt the most are those looking for take-out financing or extended bridge loans on highly levered development properties still in the process of stabilizing.
However, opportunities will still unfold down the road. We will see opportunities arise in two key areas:
- An owner may be forced to sell if his property has been too highly leveraged due to lease-up expectations, and those expectations were not met.
- An owner may be forced to sell if he is getting margin calls on periphery businesses, and liquidity needs to be placed elsewhere.
As a result of the economy, we may also see self-storage move back to more traditional growth, as owners focus more attention to traditional ways of running a business, concentrating on renting and occupancy.
Portfolio growth will happen through development and the odd acquisition. More depressed product will be sold. We will not see the consolidation we have seen over the past few years. The market will return to value buyers and less financial engineers. There will be adjustments in cap rates. How much they adjust will depend on how much product hits the market and in what time frame, as well as the degree of distress on the owner. If everything hits the market at the same time, cap rates will have more meaningful movement, and the worst product will be the last to go, unless priced properly.
Financing the Best
One point to highlight in this economic transition is investors are only investing in the best operators. Likewise, the best operators cannot rely on banks or financiers the way they have over the last five years. Capital will come in the form of mezzanine financing or equity. With their capital, some storage owners will be in excellent positions to take advantage of distressed assets that fit their portfolios as well as the ability to take advantage of cheaper land or buildings for conversion.
We are currently seeing investment opportunities with operators and developers who have good track records with existing facilities or developments. There is opportunity to invest with these businesses to foster growth through acquisition of land or build onto existing properties. Matching equity with existing business operators and developers is one unique situation arising in the absence of big institutional financing.
We are also seeing less competition from more traditional forms of commercial real estate providing self-storage owners with increased opportunity to compete for prime real estate and buy at attractive prices. Our industry is still in demand, and we have more opportunity to grow in underserved markets compared to more traditional real estate. While other forms of real estate asset classes may weaken, self-storage should remain competitive and continue to grow.
Michael Foy founded Foy & Co. Investment Real Estate Services, a full-service company specializing in raising equity and brokerage services for the Canadian self-storage market, in 2002. The company publishes the “National Self-Storage Review," an industry newsletter that reports on the Canadian self-storage market. Jenna Charlton is the company's communications coordinator. For more information, visit www.foyco.ca.