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The State of Real EstateChange, overbuilding and the future of self-storage

February 1, 2000

5 Min Read
The State of Real EstateChange, overbuilding and the future of self-storage

The State of Real Estate

Change, overbuilding and the future of self-storage

By Michael L. McCune

It has been a year since I last explored the real-estate aspects of self-storage indepth in this publication. The momentum of the last millennium has carried theself-storage industry to new heights and in new directions. The question, of course, is:What does the first few years of the next millennium hold for the industry as it relatesto real-estate values and liquidity?

One word comes to mind: change. It is apparent that many of the constants wehave known (or thought we knew) in the past are now changing, and these changes will havea dramatic impact on the value of our investments. The major question that we must come toterms with is: Are these changes simply the continuation of the ever-present cycles of ourprevious experience, or are they systemic, thus rendering our past experience invalid tojudge the future?

Let's begin our exploration by gathering some facts about the current market, hoping toget some perspective for the future.

Overbuilding

We all know that one of the single largest issues affecting the self-storage industry,both in regards to cash flow and investment values, is the impact of potentialoverbuilding. Unfortunately, the magnitude of the problem is not well established. Thereare no reliable, national numbers available on new facilities being constructed, and thosenumbers that are reliable are usually developed for aspecific site.

However, despite the fact that the magnitude of the problem is difficult to quantify,it does not mean that over building does not exist. As owners look at their own marketsand submarkets, there is substantial, anecdotal proof that overbuilding is becoming aserious problem. Overbuilding, as we have explored before in these pages, can have amaterial impact on rental rates, occupancies and overall real-estate values. (For twoarticles on this topic, visit www.selfstorage.com.) Clearly, we are in the phase of themarket cycle where overbuilding is occurring. The question is just how significant is itto the individual owner and to the overall market.

Financing

We know from talking with friends in the financing business that not many of you arecurrently seeking refinancing. We are all aware that sales have gone up substantially fromthe lows of 1998. Thus, "sticker shock" of higher rates and optimism thatinterest rates will go down have probably caused many to sit on the sidelines waiting forbetter times.

Unfortunately, we see some troubling signs for those who will need to refinance in theintermediate term--say 24 to 36 months. First, because of the lack of business lenders areseeing, many of these "conduits" are beginning to leave the business. While acouple of really good lenders remain, it certainly means less competition at borrowingtime. We also hear that many local banks are increasing their underwriting standards andare less likely to consider the facility on its own merits, but rather will place morereliance on the credit of the owner, i.e., net worth apart from the project. Secondly,overbuilding will reduce rental rates and occupancies on some, if not many, projects. Thisfact, combined with higher interest rates, will cause a reduction in the amount a lenderis willing to loan on a project. There have been several individual situations whererefinancing cannot liquidate the existing first mortgage because the combination ofdeclining rental rates and occupancy along with increasing interest rates simply does notprovide the lender with sufficient coverage to make the same loan.

The prudent owner with an intermediate term financing decision should consider"locking up" available financing while there is competition in the market andmoney is available so your project can support loan-to-value ratios sufficient torefinance the existing debt. You can always refinance again if the rates go down.

Changes in the Industry

Now that we've hit the millennium mark, we find the last century had more changes thanthe previous 900 years. On Jan. 1, 1900, how many people would have believed there wouldbe more horseless carriages than horses; children would spend 38 hours per week watchingTV or on the computer; one could fly from New York to San Francisco in four hours; or thatonly 3 percent of the population would work on farms? And certainly no right-minded personwould have believed people would pay $100 per month to rent a storage shed, especiallywhen you had a perfectly good barn.

The point of all of this is simply to say the rate of change is increasing and willimpact our embryonic industry as well as the rest of the economy. This change will createopportunities as well as challenges. While we tend to think of conventional overbuildingas our single most difficult issue, the future may define obsolescence as our greatestchallenge.

Take a moment to think about a couple of changes that are becoming visible, if theyaren't already important. Drop-off storage is a great example--the providers are stillworking the bugs out, but if they find the right formula, the industry could changedramatically. The Internet also provides many interesting opportunities. For example, if(and granted it's a big "if," but so was TV in 1945) the Internet really doesbecome the principle method of marketing self-storage, will location still be the singlegreatest marketing tool? Obviously, the successful owners and operators will be those whokeep ahead of these changes and react accordingly. Carefully monitoring the value of yourinvestment will be even more important in the future.

It's difficult to see into the future very far, but we have attempted to peek aroundthe first corner of the new millennium. What we find are some short-term"bumps," most of which we have seen before and will likely see again. However,we also see the shadows of greater changes further into the next century (maybe even justthe first decade) and know that we must be alert and responsive to the changes.

Michael L. McCune has been actively involved in commercial real estate throughoutthe United States for more than 20 years. Since 1984, he has been owner and president ofArgus Real Estate Inc., a real-estate consulting, brokerage and development company basedin Denver. In January 1994, Mr. McCune created the Argus Self Storage Sales Network(ASSSN), now the nation's largest network of independent commercial real-estate brokersdedicated to the buying and selling of self-storage facilities. For more information, call(800) 55-STORE.

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