Industry Outlook for 2008

February 1, 2008

5 Min Read
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Investor interest in self-storage assets continues to intensify as strong fundamentals and solid returns lure buyers who traditionally sought other property types. The self-storage market has also demonstrated resilience in times of fiscal decline, while posting solid gains throughout economic resurgence.

Short-term concerns have arisen, however, stemming from the weakness in the housing market, the slowing economy and significant increases in new supply. Nonetheless, the long-term outlook remains positive, as favorable demographic trends are expected to provide a spark in the demand for storage space in the years to come.

Supply-and-Demand Factors

A slowdown in the national economy has caused some weakness in self-storage demand over the past year. Employment growth, the credit crunch and housing woes continue to weigh on the economy and, when combined with the slowdown in the housing market, have resulted in a slowdown in demand for rentals. A reduction in migration-generated demand due to weakness in the housing market is expected to limit improvement in occupancy levels in all but the strongest job markets. This trend could be partially offset by homeowners facing foreclosure in some previously overheated, high-priced markets.

Over the long term, further demand for storage space will be driven by baby boomers downsizing and the growing population of people over age 65, which may instigate migration to retirement locales. The 65-and-older population is expected to increase by 2.2 percent in 2008, the highest growth rate in seven years. In addition, this age cohort is expected to expand by an additional 12.6 percent in the next five years.

Occupancy Rates

Overall occupancy levels and rental rates for self-storage fell moderately last year. While cooling economic conditions have played a vital role in the change of fundamentals, so has the increase in completions. Developers bumped up inventory by 17 percent in 2006 and an additional 8 percent in 2007, resulting in increased competition.

The national average occupancy of self-storage properties dropped 110 basis points to 79.6 percent in 2007. Losses, however, varied by location. Industrial and commercial/retail areas recorded the largest adjustment in occupancy, dropping 150 basis points to 79.1 percent between 2006 and 2007. Conversely, in urban, downtown and residential areas, occupancy rates for the same time period remained relatively unchanged at 84 percent and 85 percent, respectively.

Despite the modest drop in occupancies, a significant positive trend has emerged for the self-storage market: The average rental period has increased across nearly all users. The average rental period in 2007 was up approximately 11 percent for both commercial (25.2 months) and residential (13.4 months) users. The rental period for military users was up almost 10 percent, and students, who have had the largest share increase in tenant mix, were the only users that had a decline in rental period, to 4.6 months.

Rental Rates

As a result of the overall slowdown in demand, average rents on a national basis declined slightly over the past year. Rent decreases varied from the size of the units, but the declines were between 1 percent and 3 percent on average. The North- Central region experienced the biggest decline last year as rents dropped between 5 percent and 17 percent. The western states remain strong, however, with rent increases between 3.5 and 8.4 percent, depending on unit size.

The Investment Market

Over the past five years, the median price per square foot for self-storage has gone up 39 percent to $68.30. While the increase lags other major property types, self-storage offers above-average cap rates. At 7.6 percent, the average cap rate is 30 to 120 basis points above those registered for other property types. Higher cap rates, combined with the probable long-term health of the industry, should continue to lure investors away from the other assets.

Despite solid fundamentals and strong returns, transaction and sales velocity were down as of the third quarter of 2007. Financing and economic worries dampened investment activity across all core product types, save office assets. Self-storage transaction activity dropped 7.5 percent year-over-year during the third quarter; however, this is significantly less than the decreases registered in apartment, retail and general industrial property sectors. Activity is expected to pick up this year.

Asset focus will vary among buyer types. Larger, cashheavy buyers are expected to favor in-fill class-A space where construction costs make additions to supply difficult. Specific attention will be paid to properties that offer amenities focused at frequent users and those in areas that do not rely on relocation-generated demand. Smaller buyers, on the other hand, will target value-add opportunities priced well below replacement costs.

The trend of developers trading properties in rent-up at certificate of occupancy has subsided. Lending requirements and closer investor scrutiny of financials have all but ceased the trading of assets on pro forma numbers. Developers may be faced with waiting until breakeven points to sell for the foreseeable future.

Looking forward, modest employment growth and continued economic expansion, albeit at a slower pace, are expected to support commercial real estate assets across property types. As underwriting standards become more stringent, investors may choose to seek out self-storage assets, drawn by elevated cap rates. Moreover, investors and lenders have shown a preference for top-tier assets in prime locations, a trend that could open opportunities in many secondary and tertiary markets. With fundamentals in the self-storage market being hindered by the housing slowdown, cap rates are expected to stabilize in their current ranges. 

Steve Ekovich is the national director of the National Self- Storage Group at Marcus & Millichap Real Estate Investment Services, based in Tampa, Fla. He can be reached at 813.387.4700 or [email protected]

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