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February 1, 2001

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2001 RealEstate Review

2001 RealEstate Review

Will there be an economic slowdown, and how will it affectself-storage?

By Michael L. McCune

In 1999, we were all so excited about the new millennium that we celebrated ayear early. Now that it's the real beginning of the millennium, accordingto some pundits, it is time to once again polish up our crystal ball and seewhat is in store for the self-storage real-estate market.

First of all, let's do a review of some things we spent some time prematurelyworrying about but that did not take place last year. These issues stilldemand a watchful eye because they are important to the liquidity of the marketand to the values of self- storage facilities.

The Economy

The economy showed surprising strength for being so late in the long economicexpansion. This was despite the best efforts of the Federal Reserve Bank to slowdown the economy. The net result is that demand for goods andservices--including self- storage--remained strong. However, as the year movedalong, the discussion of future a slowdown moved from the category of"if" to the kind of landing, "soft or hard." The impact onvalues of slacking demand are quite serious in self-storage because a $1 drop inrevenues equates to about a $10 or $11 drop in the value of the project. Whilemany people believe our industry is recession-proof, to what degree remains tobe seen.

Availability of Financing

Over the past year, there was considerable upheaval in the real-estatefinance market. Of course, by now, everyone knows the conduits have either quitthe self-storage market altogether, or become so selective as to effectively beout of the market. At the last self-storage convention in 2000, it wasinteresting that there was not one traditional lender represented. As of thiswriting, banks were almost alone in their willingness to finance self-storage.

The reality is, however, that financing terms remain really quite attractivein a historical context: modest spreads, low interest rates, relatively longterms and long amortization--all of which is good for an owner refinancing orwanting to sell. The better the financing buyers get, the more they canrationally pay for the project.

While all that sounds good, and it is, we are concerned that with banks beingthe only lenders closing self-storage loans, the availability of loans maybecome more difficult in the future. Banks are highly regulated and have beentold by the regulator in many cities to reign in their real-estate loans. Thismeans they must "underwrite" any loans with more critical standardsand not increase their overall lending levels.

Unfortunately, this could disproportionally impact self-storage because itsloans are usually small and more costly to administer than those of other kindsof real estate. They are, therefore, somewhat less attractive to lenders, whohave to ration loans to borrowers. Also, if we begin to see some defaults onsome self-storage loans, you can bet the banks will back off this category quiterapidly. Bankers are notorious for following each other in and out of marketslike self-storage.

The conclusion is that the finance markets are more fragile than they mightat first appear. If you are refinancing or contemplating a sale, you may want toexpedite the transaction to avoid a change in the liquidity of the financemarkets.


The value of self-storage is a function of the net operating income (NOI) andthe perceived risk (i.e. capitalization rate or cap rate). Clearly, bothelements of that formula are subject to some interpretation. We have seen buyersvirtually unwilling to purchase "future projected income," except atvery large discounts, if at all. The purchasers have relied on trailing NOI(from the last 12 months) for determining values. The buyers are also morelikely to adjust the cash flows for expenses that appear to be too low, such asmaintenance costs and management fees. Most are also keenly aware that after asale, real-estate taxes may increase. They will adjust the cash flows to reflectthese additional costs.

Cap rates are always an interesting topic of discussion. Essentially, caprates are a shorthand way of combining the perceived risk and the expectedreturns when valuing a property. The lower the cap rate, the higher the price,because to arrive at value you divide the NOI by the cap rate (as a percentage).To compare cap rates between properties, the definition applied to NOI must bethe same for each property--and they seldom are. Thus, many discussions of caprates are not meaningful because they are utilizing two different NOIassumptions.

Often, we see sellers and buyers describe the same transaction with twocompletely different cap rates, i.e., "I sold at a 9.5 cap rate," and"I bought at a 10.5 rate." To the extent that bragging rights areimportant, cap rates can accommodate them. With all that said, and assuming theNOI figures are all based on similar definitions, here are some general commentson what is happening in the marketplace to cap rates and what we expect to seein the new year:

  • For the highest quality properties in high growth markets and "protected" locations, cap rates will be in the 9.5 to 10.5 range, depending on the area of the country. This applies only to a relatively select group of properties and markets.

  • Properties that are not "pristine" in all characteristics receive cap rates from 10.5 up to 12 and even occasionally higher.

A couple years ago, when the REITs were busy acquiring portfolios, cap rateson the best properties were lower, but generally not as low as advertised. TheREITs are not as active in buying properties today and, thus, some of thepressure on cap rates is now gone. Cap rates are once again in the general rangethat has prevailed in the industry for many years. The exception today would bethat cap rates on marginal properties tend to be somewhat higher than in thepast, but not uniformly so. (To get an idea of the issues that impact cap rates,see the article titled "Cap Rates and Sales Prices" at www.selfstorage.com.)

A Word on Selling

It appears we may anticipate some slowdown in the economy, which will impactself-storage operations to some degree. We foresee the potential for disruptionsin the availability of financing for real estate in general, as well asself-storage. As in all economic slowdowns, buyers tend to be more cautious anddemanding, making sales of properties more difficult.

A word on selling is appropriate at this point. Well-located, qualityself-storage is just about the best real-estate deal around. If you own such afacility, you shouldn't sell just because of an economic slowdown. If you sell,you should have another reason, such as retirement estate planning. If you seesuch an overriding need to sell in the near future, do it now, otherwise hold onand simply realize the business may not be quite as good as it was the last fewyears. The advantage is that you don't have to worry about how or when to getback into an ownership position of this great piece of real estate.


Clearly, we can't define the magnitude of all of these possibilities now.They may well be minor or they could be major, but it is prudent to anticipatethe potential negatives that may appear. In other words, if you need torefinance your facility, do it now. It may not be the best deal you can ever doin the present, but at least it is a deal that will work well in the future andensures your ability to keep the property. If you anticipate selling in theintermediate term, now is probably a good time to start the process. Thereal-estate cycles usually run anywhere from three to five years. So unless youwant to wait out the cycle, now is a good time to sell.

Michael L. McCune has been actively involved in commerical real estatethroughout the United States for more than 20 years. Since 1984, he has beenowner and president of Argus Real Estate Inc., a real-estate consulting,brokerage and development company based in Denver. In January 1994, he createdthe Argus Self Storage Real Estate Network, now the nation's largest network ofindependent commercial real-estate brokers dedicated to the buying and sellingof self-storage facilities. For more information, call 800.55.STORE or visit www.selfstorage.com.

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