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The Good, Bad and the Ugly of Self-Storage Overbuilding

The Good, Bad and the Ugly of Self-Storage Overbuilding
In many markets, self-storage is overbuilt, and yet the industry is red hot. The cyclical nature of the business reminds us that we’ve been in similar situations before, and there are already signs of coming change. Read about the current state of industry development and where it’s likely heading.

Let’s face it: The self-storage industry is overbuilt. There are simply too many facilities chasing too few tenants. We’ve been in this predicament before. In fact, this was the state of the industry in many booming U.S. towns back in 2001. We’d been through the devastation of 9/11, and the tech bubble had just burst. Newly built storage facilities were slogging along in certain markets at 55% occupancy. Many in the industry were just getting by.

We recovered from that in time to be hit by the Great Recession of 2008. Once again, we suffered through years of financial tightening and hardship until the economy and commercial real estate sector turned the corner. Things have been moving forward ever since.

Today, we have more than 50,000 self-storage facilities operating in the United States. There’s nearly 6 square feet of storage for every person in America! Does this mean the industry is overbuilt? Yes, most certainly—in some markets.

The old-school industry drivers of death, divorce, dislocation, downsizing and natural disasters have been turbocharged by the COVID-19 pandemic. The work-from-home trend has created still further demand. In addition, the federal government has pumped loads of money directly into the economy over the past few years, and the Federal Reserve has kept interest rates very low by historical standards.

All of this money sloshing around has caused the price of almost everything to escalate rapidly, especially housing. These factors have all added to increased demand for storage space. The investment viability of self-storage as an asset class has exploded, and developers have responded in kind. All these new disruptions have caused self-storage to become a permanent way of life. Will it stay this way? We shall see.

Let’s explore the good, bad and ugly of the where the industry is right now and where it’s likely headed in this cyclical business.

The Good

Self-storage has never been better. It continues to be a successful and strong asset class for investors. Capital is readily available for new construction as well as renovation and expansion of existing sites. Developers have responded by building new, modern facilities with all the latest bells and whistles, while older, big-box retail spaces continue to be converted. In many cases, developers are simply building to resell the store for a quick profit. Amazingly, these new properties have leased up just fine, for the most part.

In short, the market is on fire. So, when will we quit this building boom? Why don’t we just stop building? The answer is simple: Developers and investors will continue to create new stores until market conditions dictate otherwise.

Real estate is cyclical. At some point, a change will occur. I’m an optimist, but I expect a course correction in some markets. When and how is a matter of debate. Though there’ll always be opportunities for new product, it’s incumbent on developers to strategically pinpoint those pockets!

The Bad

The highly cyclical nature of the real estate industry means it responds to basic supply and demand forces. As self-storage supply increases in a market, occupancy rates and rent per square foot normally decrease, given all other things remaining equal. The main “other thing” to consider here is market growth (number of people and/or disposable income).

Remember, we’re many years deep into an economic recovery, even if the pandemic has altered things. The value of real estate won’t continue to increase in a straight line. Again, it’s cyclical. It’ll eventually mature and trend downward. How severely is anyone’s guess, but you can bet something will change the current trajectory.

The Ugly

When I built my first self-storage facility in the early 1990s, my banker asked, “What will you do with all of those little mini-barns if no one comes to rent them?” Though renting to tenants turned out not to be an issue, his point was a good one and somewhat prescient. Self-storage is a highly specialized use. As a result, it can’t be easily converted to an alternative use if market conditions warrant.

I learned a lesson about this predicament many years ago. My first job at a commercial bank was to liquidate a loan from the developer of an indoor skateboard park. The project required lots of specialized concrete for jumps and turns and was, overall, quite expensive. As it turned out, the market for this use simply didn’t materialize, and the entire project was a financial failure. Unfortunately, nothing could be done efficiently to change the use. The building was eventually demolished, and it became a multi-million-dollar write-off for the bank.

Multi-story self-storage developments are similar in many ways. They’re highly specialized and aren’t easily (or efficiently) converted to another use. Overbuilding in a weak or highly competitive market can cause significant financial loss because these facilities can’t be re-purposed.

One bright spot here is a new, modern, multi-story facility can sometimes fill a gap or pocket of opportunity and do very well. This can be especially true if the market has older first- or second-generation properties and is experiencing growth in population and household income.

Exercise Caution

So long as there’s financial incentive to develop new self-storage facilities, more will come. When we reach equilibrium, things will slow down and stop. When you consider all the current societal factors, including historical drivers, excess wealth, impacts from COVID and inflation, it’s a recipe for a significant shift in the utilization of self-storage.

However, we need to exercise extreme care. With development booming and occupancies and rental rates peaking in some areas, there’s a squeeze for market share and viability. I believe there’s almost always room for new, well-designed and well-located self-storage. It’s just that these pockets of opportunity are becoming increasingly difficult to find.

Jeffrey B. Turnbull has been involved in the self-storage industry in Charlotte, North Carolina, as a developer, operator and owner for more than 25 years. He’s a licensed attorney in North Carolina, a licensed real estate broker in North and South Carolina, and a past president of the North Carolina Self-storage Association. He’s been a regular contributor to Inside Self-Storage and a speaker at various industry events. To reach him, email [email protected].

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