1999 State of the Industry Report

By Tom Brecke

The end of thecentury is shaping up to be an interesting time for the self-storage industry. After yearsof steady, unfettered growth, current signals indicate a possible slowdown in an industrythat has done nothing but climb since the dismal days of the early '90s when a prosperousindustry was blindsided by overbuilding and saturation of markets to the point ofdisaster.

But that was then and this is now--1999. Self-storage is an entirely different animal.Back in the early days, almost everything was a mom-and-pop operation--concrete buildingsin industrial areas of town. But look where it's gone: Wall Street's now involved;buildings are sleeker, better built and fit in with the residential landscape better thananyone ever thought possible. Consumer knowledge of self-storage has sky-rocketed,planning and zoning boards have begun to see its importance, and they often embrace itspresence in the community. Society knows now what we've known for a long time:Self-storage is a valuable product.

With that, however, comes some concerns. Namely, overbuilding, occupancy and availablefinancing. This article will examine the state of self-storage, tapping the knowledge ofsome of the industry's top insiders. And while it didn't seem long ago that the year 2000looked far off, here we are. Consider it a chance to take a look backward and trace thesteps of how a niche industry such as self-storage truly came to the forefront as aviable, respected business.

Looking Back

A little morethan 10 years ago, the outlook for self-storage business wasn't so rosy. By the mid-1980s,the idea of making money in self-storage was no longer a secret. The market went into abuilding frenzy, sent investors scrambling for capital and pushed it to its saturationpoint by over-supplying the demand. The industry that was once a shining star had lost itsluster as stiff competition, low occupancy rates and high mortgage payments doggedoperators around the country. This low point in self-storage continued into the early partof this decade as occupancies fell to their lowest point in 1990-1991 and the industryitself hit rock bottom from 1990-1992. Many facilities were repossessed by banks as wellas the RTC, and values fell from the heydays of the mid-'80s.

By the middle of this decade though, things began to change for the better. Occupancycaught up with the heavy supply while the nation's economy strengthened. Financing firmsloosened their tight reins and full-scale construction began again.

Where Are We?

Themillion-dollar question in all of this is: Will the good times last, or are we headed fora downturn? The nation's economy still looks to be in a bull market as outward signs showstrength, but the foundations may be showing some cracks. Of course, it depends to whomyou talk, but as the stock market has begun to gyrate and look more like a rollercoasterthan an upward ramp, some people are holding their breath as to the true health of theoverall economy. Not the least of which is the effect of the Asian economic crisis thathas begun to spread to other countries, including the United States, where high-tech firmsare beginning to report losses from the overseas slowdown.

For self-storage, over the past couple of years, "cautious optimism" seemedto be the key phrase many operators and industry vendors were uttering when referring tothe state of the industry. For the most part, that still holds, though some have moved toa more "cautious" tone.

"I said the same thing last year, but I'm even more sure of it this year,"says Maurice Pogoda of Farmington Hill, Mich.-based The Pogoda Companies. "We're onthe other side of the mountain. In 1994, '95 and '96, we were definitely still heading upthe mountain. When we look back, I think we're going to say that 1996 and '97 were thepeak years, and in 1998 we suddenly started heading down the other side."

Pogoda, who works in the state of Michigan, says he sees occupancy rates declining fromwhere they have been in the past couple of years, which he chalks up to increasedcompetition. "I was looking at the Yellow Pages ads for new comparables for all mysites and I came across a couple of sites I was not even aware of, and I think I'm prettywell in tune with my marketplace."

Others, such as Dave Reddick, president of Sentinel Systems Corp. in Lakewood, Colo.,concedes that he's been waiting for a slowdown from the spectacular growth that hasoccurred in the self-storage industry, but so far it just hasn't happened.

"We've had a very good run for a long time, just like the U.S. economy," saysReddick. "You just keep waiting for a something negative to happen and sort of lookover your shoulder, but we just haven't seen it."

Mike McCune of Argus Self Storage Network in Denver, points to a quote by FederalReserve Chairman Allen Greenspan when asked about the state of today's self-storagemarket: "The exuberance is out of the market." And while the bloom may be offthe rose of the nation's economy, McCune says there is plenty of success to go around inself-storage today. He says some areas may be overbuilt, but the overall look of theindustry is far from a crisis situation.

Overbuilding and Saturation

With facilities seemingly popping up all over the country, many are concerned thatmarkets are being overbuilt, with little forethought into where the store will be located.Although money has seemingly been flowing readily in the past couple of years, proper duediligence, planning and feasibility studies are not being done by some, reminding peopleof the '80s downturn that led to the bad times of the early '90s. Like any smart developerwill tell you, just because you own a piece of land, doesn't mean it's ideal for storage.

Not all markets are overbuilt, though, and like most industries, self-storage can bevery cyclical, especially in different areas of the country. While one quadrant of theUnited States may be going strong, another could be struggling. The fact that self-storagedraws clients from a three- to five-mile radius lends itself to clustered areas that maybe seeing a slowdown, while across town it could be wide open for development.

According to Mel Holsinger of Executive Self Storage Associates based in Tucson, Ariz.,that's exactly what's happening to many areas of the nation. Of the nine different marketsin which Executive operates, he says some are growing, some are stable, others are introuble.

"The reason the markets are so different is the timing of the development that hasoccurred over the last four to five years. Tucson, for example, has had an exceptionalnumber of projects brought into the market in a short period of time, but the populationhas grown only slightly," explains Holsinger. "Phoenix, on the other hand, hashad a lot of new product built, but the economy is such that it's also growing inpopulation at a dramatic pace. The supply and demand is staying pretty solid."

Dave Cook of Tacoma, Wash.-based Tech-Fast Metal Systems believes some areas of thecountry are becoming overbuilt, but says most people are looking closer at the market forniche opportunities within particular communities.

"The level of activity, and probably the frenzy surrounding it, has softened alittle bit, but the number of qualified builders and the number of contracts--from ourperspective--is staying very strong," relates Cook. "I think what we're seeingis that over the last couple of years, we were getting a lot of calls from new people, andthat's still the case. But, we've weeded through a number of people that looked at itcasually. The serious builders, the people that have been building for a number of years,are staying strong. You're still looking at a lot of opportunity out there."

U-Haul International's Carlos Vizcarra agrees that there is plenty of opportunity outthere, adding that U-Haul hasn't seen any slowdown at all. He admits though, that there issome congestion as far as facilities go, but that it's part of the business.

"We see too many facilities coming up, but that's just the nature of competitionand everyone in the industry has to deal with it," he says. "We look at themarkets with a very small radius, so it's hard to say that any one market--likePhoenix--is overbuilt. Success in the industry is based on the location, like any retailbusiness. You may have a saturated market, but it you have the best location in thatmarket, you're still going to be successful."

Kent Greenwald of real-estate firm CB Commercial, agrees and says more and moreoperators are looking at niche markets, rather than writing off an entire area becauseit's believed to be overbuilt. Much of that, he says, is because of the different rolethat self-storage is playing in society today.

"One of the things we're finding as we do more and more studies, is that theself-storage business is now really being perceived more as a retail use rather than anindustrial use. Twenty-five years ago, we'd go along the freeway and build a warehouse asan alternative use, thinking it would be torn down someday," relates Greenwald."What's happening now is that companies are willing to pay more money for retailfrontage. We're starting to use high-tech devices like global positioning systems, mappingsystems and other demographic programs to try and find areas within cities that meet acertain criteria. Phoenix has 5.4 square feet of self-storage per person--which manypeople would say is a saturated market--but there are still niches within this market thatcan provide a very beneficial return on a self-storage investment."

As an example, Greenwald points to the restaurant industry in Phoenix where the marketis also very crowded, despite the fact that development continues. "There arerestaurants coming here everyday because they provide a particular product in a certainsub-market that they think will be successful." As far as feasibility studies areconcerned, he says the three- to five-mile radius is still used as a gauge, but adds thathe's seen many operators in dense urban areas drawing a large percentage of their businessfrom within two miles.

Buster Owens of Ocoee, Fla.-based RabCo Corp. says he hasn't seen much sign ofoverbuilding, except in a few markets such as Las Vegas. "We are seeing places thatthey are starting to shy away from because there are so many facilities going in,"relates Owens. "But they're finding other places to go instead. It lends itself tothe way that the self-storage market is--they draw from a small radius. So one side oftown might be saturated, whereas the other side of town isn't. Instead of building in say,Orlando or Tampa, Fla., they're building in Bradenton or Winter Springs, Fla.--surroundingsuburban areas."

Owens and others say the Northeast looks like a very promising market, after strugglingsomewhat to catch the wave that much of the rest of the country already has. "There'sa lot of activity up in the Northeast, and not just conversions, but new construction thatwe haven't seen over the last few years," he says.

Doug West of Doug West & Associates, which supplies security systems to theself-storage industry hasn't seen any slowdown either, and expects business to keepgrowing for the upcoming year.

"What I see happening with vendors is that the little guys are starting to fadeaway or look at other markets," says West. "I think that's because the majorplayers are looking at the vendors closely; what they are seeing is stability, and they'retrying to make an evaluation based on stability and size."

According to Reddick of Sentinel Systems, also an industry software and securityvendor, self-storage owners and operators are much more educated and informed about theindustry as a whole than they were even seven or eight years ago. "You have a certainpresence that you didn't have a few years ago with the REITs and certainly more visibilitywith companies like Storage USA and Storage Trust," says Reddick. "In the past,when you talked about software and automation, it fell on deaf ears for the most part.Now, nobody builds anything without putting in a software program or electronic gatecontrols--many are even doing door alarms. That's a result of education followed bycompetition and visibility."

Slowdown Ahead?

Even though the market looks strong, veterans of the industry are still bracing for aslowdown, much like investors waiting for the inevitable correction that will come to thesurging stock market. But like many will tell you, a slowdown in the self-storage industrywouldn't necessarily be a bad thing. Like the stock market, a slight downturn inself-storage could serve to keep everyone in check and not let those that haven'texperienced a sour market run amok.

"I wouldn't say that a slowdown would be alarming," says Tech-Fast's Cook."It's a more mature industry that's going to follow trends of the overall nationaleconomy."

Others say a downturn would "skim the fat" so to speak, and probably won'taffect the veterans in the industry that have been down this road before.

"I still think that the experienced, seasoned veterans that have been throughthese up-and-down cycles are going to be the ones surviving," says Executive'sHolsinger. "I think there's a lot of trouble ahead for people who haven't beenthrough a down cycle and are not prepared for it. Obviously, the people that leveragetheir product right are going to be in the best shape. Unfortunately, I see people outthere going gangbusters and saying, 'It's been so great it has to continue.' They'relooking at today; they're not looking at what's going to be happening three years fromnow, and I think that's a major mistake."

Financing

Financing, ofcourse, plays a major role in determining whether self-storage is or will becomeoverbuilt. For the past few years, banks and other lending institutions have becomenotoriously easy to obtain financing from for the self-storage industry. While not at theproblem levels of the savings-and-loan crises of last decade, grumblings have begun to beuttered about the lack of experienced developers getting loans with little or no duediligence and feasibility studies.

The money is still there, but most in the industry agree that the money companies arefeeling some crunch and beginning to inspect self-storage and other loans moreclosely-something most say is a welcome trend. "Lenders have got to get a littletougher now," says Pogoda, who agrees that money had gotten extremely easy of late toobtain. "I think people have kind of opened their eyes a bit and are worried aboutoverbuilding. Lenders have started asking more questions than they were in the lastyear."

Dean Keller of Rancho Santa Margarita, Calif.-based Bancap Self Storage Group, saysfinancing has become more stringent, and in a very short period of time. "Financinghas gotten real tight and has happened so quick that it's hard to tell how long this isgoing to last," he says. "It's still too early to tell if this is going to beshort term, or if this is going to put a damper on the finance market for a fewyears."

Keller says the tightening of financing, especially the drop in conduit loans, which ishow many self-storage loans are completed, is also affecting the buyers and sellers ofstorage property. "Everybody was doing great, but now we're starting to see theimpact of all the new construction that's been coming on line last year and thisyear," he explains. "Suddenly, there's this liquidity crunch that is impactingthe REITs and the private party's ability to buy property. I see it as a temporaryphenomenon. It would concern me if it were a long-term trend, but it happened so suddenlythat I don't thing it's going to last."

Mike Burnam of industry REIT Storage Trust, which recently announced it would mergewith Public Storage, doesn't see a rebound quite as fast and thinks the financial slowdownwill hit the private sector around the end of the first quarter of 1999. "What we'reseeing is a slowdown in growth and supply in most markets and that's just the beginning,because the lenders are just now realizing some of the credit crunch that the publiccompanies have realized over the past four months," says Burnam. "When thatcomes to fruition, I think that there is going to be a dramatic slowdown."

Cook says he believes financing will generally follow the the overall health of theU.S. economy. "Financing is still available and affordable, although that could betightening up over the next few years," he says. "I see financing basicallyfollowing the performance of the stock market and the availability of funds as long asinterest rates are kept low, and I think that there is a good reliability to that. We area large enough industry now that it really seems to be revolving around the stock market,interest rates and general economic growth and less on the peculiarities of our particularbusiness and more so on the health of the nation's economy in general."

Argus' McCune adds that the tightening financial markets are going to force potentialbuyers and developers to do more due diligence and feasibility studies--something he saysisn't currently happening as much as it should.

"The rates people borrow at have impacted the rates of return people can expectfrom owning or developing," explains McCune. "I think the best way to mitigatethat is to encourage people to do a feasibility study to determine whether the market isgoing to be able to hold this or not. Fortunately, there are some institutional investorsthat are insisting on that now and people are doing more homework."

The Future

What the future of the self-storage industry holds is anyone's guess. Most signs pointto a slowdown, especially for the REITs and their buying prowess. Industry veterans, mostof whom have been through the ups and downs, don't seem to be worried. McCune says aslowdown may stop the "hyper-aggressive buying" that he's seen for the pastcouple of years, but the buyers will still be there--they'll just be more selective.

But as the turn of the century approaches, the industry seems poised to continue togrow as an industry, maybe not as fast as in the second half of the '90s, but it willgrow. Like Pogoda says, a slight slowdown might "give everybody a chance tobreathe."