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Hidden Value: Where to Seek Value-Add Opportunities in Today’s Self-Storage Market

Hidden Value: Where to Seek Value-Add Opportunities in Today’s Self-Storage Market
Current real estate dynamics have self-storage buyers scouring the market to find high-yield deals, which can be difficult to uncover. Here are tips on where to find underperforming assets and how to mine for value-add opportunities in this buy high, sell higher market.

School supplies have been purchased and fall is in the air, both clear signs that summer is coming to an end. I’m not nearly as confident, however, that the self-storage run up in valuation is over. In the last 20 years, I’ve never seen market fundamentals so strong, and the current market is unique for many reasons.

For starters, treasury-bond rates have stayed low, driving down already record-low mortgage rates and making access to capital very fluid. Further, new demand that was created during the pandemic is seemingly here to stay, driving occupancies to record-high levels. We’ve also seen new development continue to slow nationwide, and forecasters say new construction will be impacted for the next few years. This is due in part to increasingly long entitlement and approval processes as well as rapidly rising construction costs. This truly might be a buy high, sell higher self-storage market!

In response to these conditions, self-storage buyers often want to find embedded value, or underperforming assets. These types of deals can be difficult to find, but if you dig deep and take the necessary action to create value, you’ll be rewarded. Following are some observations that’ll help you find these value-add opportunities in today’s market.

Recently Oversupplied Markets

We’re starting to see self-storage operating fundamentals firm up in markets that experienced a lot of new development in the last 12 to 36 months. Buyers have shied away from these areas over the last few years, so now may be the time to act. Most of these markets have continued to enjoy strong population and job growth, which has allowed rental velocity to remain strong. In most cases, we’ve started to see rates rebound quickly.

Average street rates on 10-by-10 units are up 10.6% and 12.7% for non-climate and climate-controlled units, respectively, with some markets experiencing increases of more than 20%, according to self-storage data-services platform Yardi Matrix. As a result, we’re seeing meaningful value created in several markets that have been widely overlooked the last few years due to oversupply, such as Austin, Texas; Denver, Colorado; and Portland, Oregon, to name a few.

The reality is these markets weren’t oversupplied; there was just a glut of new product that hit the market at the same time and needed to be absorbed. A careful study of existing supply and pending development in a specific trade area should be completed to ensure projects aren’t at risk. It’s worth noting, however, that we’re continuing to see many pockets of opportunity in markets that have been traditionally thought of as saturated.

Secondary Markets

A significant number of self-storage capital providers are now making investments in secondary markets, which continue to perform well for a variety of reasons. Yields in primary markets have gotten very thin, while quality third-party management is now available in these rising secondary markets. There’s also been meaningful population migration during the pandemic, and most of these secondary areas have experienced significantly less new development.

Secondary markets have always been difficult to define, though they should have a population of at least 200,000, be within a two- to three-hour drive of a top 50 Metropolitan Statistical Area, and have daily/weekly commercial airline service. The job market should be growing alongside increasing population figures.

It’s clear these markets are of interest to many well-capitalized buyers, but everyone needs to keep perspective. Valuations will be adjusted for the added risk of being in a smaller area. In strong secondary markets, acquisition capitalization rates are 10 to 75 basis points higher than in major markets. You may also need to dig deeper into your operational review of assets in these areas because the lack of sophisticated operators has left a lot of low-hanging fruit and embedded value in the current tenant base.

Still, self-storage investors can capitalize on this embedded value by carefully managing rental rates to bring them up to market levels and leveraging technological advancements in revenue management and facility marketing. Don’t be afraid to look in less-traditional markets to find these under-managed deals, as there can be significant upside.

Lease-Up Deals

Lease-up deals are also gaining traction, as there’s meaningful value to be created by stabilizing discounted rental rates. During the current building cycle, the profile of the typical self-storage developer is significantly different than in the past because our industry has attracted builders from other real estate classes such as apartments, office, retail, etc. In many cases, these folks are new to self-storage and don’t understand the operational nuances of the business (pricing, lease terms, tenant rollover, expenses, etc.). They also aren’t accustomed to the historically long lease-up and stabilization timeframes of the sector (three to five years).

Similarly, developers who started to build early in the cycle enjoyed hyper-absorption and unrealistic pricing power from 2012 to 2016, and this experience has set their expectations artificially high. As a result, there was a glut of new self-storge properties developed from 2015 to 2019, with many projects just now starting to show signs of stabilization. For the first time in several years, these operators are enjoying rental-rate increases, which we anticipate will continue for the next several years.

These market conditions have created buying opportunities for investors who have a better operational understanding of the self-storage business model. For example, there are facilities for sale that are 25% to 75% occupied and have been in lease-up for two to four years. Many of these are in major markets that have experienced a large amount of new supply delivered in the last one to three years.

Those interested in acquiring need to take a long look at these late-lease-up investments because the buyer pool and pricing have increased for these assets. Still, for the long term, these new, well-constructed, mostly multi-story assets tend to be very well-located in top markets. In the next one to five years, we’ll undoubtedly continue to see pricing power swing back to the owners, and these class-A assets will perform at a very high level.

Today’s self-storage real estate market requires buyers seeking value to look harder and further down the road. That said, if you’re willing to do the work and set your investment horizons at a realistic level, you can still find acquisitions that’ll provide value-add opportunities and above-average returns. Remember, this is a buy high and sell higher market!

Ben Vestal is president of the Argus Self Storage Advisors, a national network of real estate brokers who specialize in self-storage. Argus provides brokerage, consulting and marketing services to buyers and sellers via an extensive marketing platform for self-storage properties. Property listings and informational resources can be found at. For more information, call 800.55.STORE; email [email protected].

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