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January 1, 2000

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State of the Industry ReportA look into the year 2000

State of the Industry Report

A look into the year 2000

By Teri L. Lanza

"I never think of the future. It comes soon enough." ~AlbertEinstein

That it does.

A year ago, InsideSelf-Storage conferred with industry experts--crooned to the crystal ball, so tospeak--in an attempt to catch a glimpse of the year ahead. Well, that year is complete,and here we are chasing insights, not only for the upcoming year, but for a whole new era.Now that we're barely recovering from another prosperous and promising spell, the questionsitting on everyone's lips is, "How long can it all last?" Do the next 12 monthsindicate a strict diet of "more of the same," or will the dreaded downturn atlong last be evidenced?

It isn't about stark metal buildings anymore, and everyone knows this. It's no greatsurprise that "storage" has made it's way onto more and more households' andbusiness' monthly list of expenditures. What is surprising, according to industrygurus, is that good fortune has come to roost for as long as it has, and souncompromisingly. What began as a difficult and uncertain decade has evolved into an epochof unfettered growth for developers, owners and vendors alike.

Here, we'll examine the current state of the industry and where some of its moreseasoned insiders believe it to be headed in 2000. Consider it your opportunity to lookbehind the curtain. The future may arrive soon enough, but there's certainly no harm inanticipation.

Let's Recap

The state of self-storage now as opposed to 10 years ago is a world of difference, andgratefully so. "The dramatic changes we've seen are in how the industry has grownup," says Maurice Pogoda of Farmington Hills, Mich.-based The Pogoda Companies."The big things that have happened have been in the real-estate cycle. In the early'90s, things were just plain awful, due to the Savings & Loan crisis and the creditcrunch. There was an overabundance of storage space, and buildings just weren'tfilling."

By the mid-'90s, things had begun to improve, with occupancies rising and owners beingable to raise rents. There was also a resurgence of capital at this time. "Thedevelopment that had been entirely stifled in the early '90s went into high gear,"says Phoenix-based CB Richard Ellis' Kent Greenwald. "It started out a bit slowly,but by the time we got to '95 or '96, the REITS were also on their spending sprees, whichmade for a very active market." Rates began to skyrocket, occupancies were high, andthe real-estate investment trusts were offering outrageous prices to buyproperties--prices that, as Pogoda points out, were not sustainable by anyone but a REITwith its lower cost of capital and desire to build marketshare.

There was another element entering the mix at this point as well: A tremendous numberof developers who had been damaged in the Savings & Loan crisis and had never builtself-storage before stumbled into what they discovered to be a very easy industry toenter. "Self-storage was much easier than constructing the office building orcomplete shopping center that they might have built before," Greenwald explains.Development began to boom.

No Time Like the Present

Since then, development has remained steady throughout the country, to the point whereoverbuilding has become an issue in several areas. There are still some hot markets,however, primarily in major metropolitan areas with dense populations, areas such asWashington, D.C., Los Angeles, San Jose and San Francisco, Calif., according to Greenwald.

Dean Keller of Bancap Self Storage Group in Rancho Santa Margarita, Calif., agrees,although he, too, acknowledges the impending possibility of saturation. "Right nowthere are more buyers in this industry than ever before and, unfortunately, at least outon the West Coast, there aren't as many sellers as we'd like to see," he says."Everybody in the business is doing better than they've ever done before, so unlessthere's some unique circumstance, they have no motivation to sell."

That doesn't mean there isn't danger ahead. In a market like San Jose, where there were4 million square feet of storage space, everyone was full and had waiting lists. It wasone of the strongest markets in the country, according to Keller. But now, with another 2million square feet of space either constructed or in the pipeline, everyone's getting atad nervous. "Some of the new properties that have opened are filling slower thanexpected. Things are getting a little bit scarier," he admits.

Mel Holsinger of Executive Self Storage in Tucson, Ariz., shares his experience."The Arizona market seems to have stabilized, but we're still surprised at the numberof projects proposed or that are under construction, because it seems that the occupancyof projects--at least in Arizona--has been bound in certain markets and stabilized inothers. I don't see occupancies rising significantly. And, obviously, if more projects arebrought on board, they're going to decrease. This is also making for some interestingpricing situations."

Mike McCune of The Argus Self Storage Real Estate Network in Denver says, "We'reseeing dramatic saturation in some markets, modest saturation in others and, in someareas, hardly any. Unfortunately, however, almost bigger than the problem is that we don'tknow how big the problem is. All we have is anecdotal information on specificmarkets," he says. "We don't know what the dimensions of the market are, and youlook at some of the numbers and you still see rents going up and occupancies only beingslightly impacted, but you don't know how good those numbers are either, howrepresentative they are."

Dave Cook of Tacoma, Wash.-based Tech-Fast Metal Systems notes that aside from thepotential danger of saturation, cost has become another issue. "The dynamic from ourperspective is that construction is just more expensive. The cost of development issignificantly higher and continues to go up--you're talking about the cost of land, codeapplication, growth management ... That makes it more difficult for the self-storagedeveloper and manager out there to get an appropriate return on his investment and managehis debt correctly," he says.

The result of this? Developers are having to be more discerning in their siteselection. "They're completing more comprehensive market studies and paying greaterattention to the demand/supply relationship of storage within submarkets," Greenwaldpoints out. "The business has also become much more niche oriented. Rather thanlooking at the well-publicized saturation of a major market area, developers are lookingat small submarkets or niches within the metropolitan area that can justify a storageproperty."

The Question of Demand

With the cost of development rising and site availability becoming more of a challenge,developers must address the question of demand--can it support the product? According toHolsinger, demand is increasing, though not significantly. "Every year there is moredemand for the product, and right now it seems the supply is at least equivalent to thatdemand in a lot of markets. As the demographics change, I see more and more demand in theNortheast, particularly in your more dense markets like New Jersey, Pennsylvania and NewYork. There are still a lot of opportunities, a lot of markets that are stillunderserved," he says.

Steve Cooper of Digitech International, based in Asheville, N.C., agrees that a greaterportion of the general population are using storage facilities. "It's a cultural aswell as a demographic thing," he explains. "As the facilities being built aremore modern and sophisticated, they're attracting a greater clientele. When you put infeatures like security systems, etc., you keep your commercial users happy as well, andattract a lot more professionals."

But the demand isn't strictly for more self-storage--it's for a different kindof product. "Every new facility is certainly more attractive, more oriented ontechnology, more competitive than existing facilities," says Bancap's Keller."So all things being equal, I'm seeing new properties coming on the market being ableto generate higher rental rates. Even in terms of getting the loans and appraisals done onthese projects, it's a fair bet to say that a new property will be able to getabove-market rental rates as compared to existing facilities."

Jim Chiswell of Williamsville, N.Y.-based Chiswell & Associates adds, "Basedupon my consulting work across the country, I'm seeing a growing demand for space. Averageunit sizes are getting bigger, and despite the comments to the contrary, the majority ofprojects are still being built with manager apartments (zoning permitting)." Thisindicates an enduring interest in the product, as well as a confidence in its longevity.

However, while there is certainly greater demand for self-storage and the perception ofthe self-storage product has changed in the eyes of the public, that does not necessarilymean that it has become solidified enough to withstand another recession, should it occur.According to Pogoda, "We've become a bit sanguine about how good things are, butwe're going to have to wait it out through the next recession--whenever that comesabout--to see whether storage is as commonplace as we think it is," he says."One of the concerns that we should all have is not to be too complacent about howstorage is 'trendy.' When the economy is as strong as it is, people throw money about mucheasier. I'm not a believer that this is a recession-proof industry. I've not witnessed it,and my experience has been just the opposite."

Maturation or Saturation? Now What?

Although McCune firmly believes self-storage to be looking at a year of greatuncertainty--based upon the industry's dependence on the general economy--most of ourexperts indicated the upcoming year will not witness any dramatic changes, particularlynot a significant downturn or slowdown in development. "They've been talking about adownturn in this industry for three years now, but the only thing we see is that it keepsgetting stronger," says David Reddick, president of Sentinel Systems Corp. inLakewood, Colo. "We've just had our best year yet, and that's partly because of ourproduct and service, but partly because the industry is strong. I don't see anythingslowing down in the near term."

Digitech's Cooper agrees. "If you listen to the futurists who have been speakingto our industry at various tradeshows and conferences, they are--for the mostpart--speaking in contradiction to the Wall Street prognosticators who say we're going tohave a downturn and inflation is going to go crazy again. The industry speakers are sayingthat, primarily because of the Baby Boomers, we're going to see a real bull market for thenext five to seven years." While there was little indication that most expertsbelieve the industry's good fortune will hold out that long, the overall sense is that itwill at least carry us through the next year.

"Economic conditions are still favorable for the development ofself-storage," says U-Haul International's Carlos Vizcarra. "The major barrierto entry that we see is just the restrictive zoning statutes in many municipalities, butother than that, the economy is still supportive." This does not mean, however, therewon't be a certain amount of stabilization of the rate of development. Tech-Fast's Cookdoes predict a leveling off. "More and more, the dynamics of financing and overalleconomic health for the country is what dictates our ability to continue to develop,"he says. "We have not seen any indication filtered through our efforts that there iswaning interest for the product from the public, and I would have to say, in general, thatover the next year we'll see a level of development activity comparable to recent years.But the signs are out there--we've grown into an industry that can be impacted by generaleconomic forces out of our control.

"The forecast is for stock-market performance, availability of financing atreasonable rates, fear of inflation, etc. If we begin to see any significant stock-marketdips or high consumer-debt building (which is kind of what is occurring at themoment)--some of those signs start to chip away at the wonderful growth that we've had. Ithink forecasters would say that just one of those things happening can be enough to pushus into a slow-down or recessionary time period. They're saying that things will calm downin a year, possibly two--but it'll be a slowdown and not anything dramatic. I don't seeanybody just turning off the spigot. Nothing's going to just stop. Will they level out?They certainly will."

Regardless of what may be the most realistic prediction, there is still a lot ofoptimism out there. "Absolutely we are looking at another good year," assertsCooper. "I think it's going to be an astounding year." And according toChiswell, "I think 2000 will continue to be an excellent year for our industry. Thereare a number of projects already under construction that are coming online. These newprojects, like the ones opened over the past several years, are going to have an impact onthe older projects. The new, state-of-the-art projects will continue to erode themarketshare of many first- and second-generation projects."

So let's talk about that for a minute. If what Chiswell and Keller tell us are true,and the newer, more sophisticated properties will eventually supplant the older buildings,where is development being driven? What about the higher cost of construction and limitedsite availability? How will those things change the landscape of development over theupcoming year?

"I personally believe that new building is going to slow down, for a lot ofreasons," Pogoda explains. "First, the cost of capital is going up. Second, thecost of vacant land has skyrocketed. Land that we'd pay $2 a foot for a few years ago isnow $5 or $6 a foot, and rental rates in self-storage have not increased that much--notenough to warrant paying those kinds of prices." A good point. But that doesn'tnecessarily translate into a slowdown of development altogether. Builders are nowexploring new alternatives. "People who are interested in moving forward are lookingat every avenue," Pogoda says. This perspective is one that seems to be shared acrossthe board.

"Self-storage is becoming a true retail-type of business, and builders arespending a lot more money on the land, a lot more per square foot than they used to,"says Buster Owens of Ocoee, Fla.-based RabCo Corp. "So now we're seeing largerprojects on smaller sites, which dictates going up instead of out. Multistory building isextremely popular. I would say 80 percent of all projects that we're doing have at leastone two-story on them. And they can afford to do that because of climate-controlself-storage being more in demand. It's easy to build up when you can climatize that spaceand get the kind of returns you want," he says.

Cook from Tech-Fast adds, "Site availability is more difficult these days. You'respending more money on a more difficult site and having to spend more to develop it.There's no question that this fact will drive more multistory building, and it has. It'sunique that we do a project that doesn't involve multistory or climate-controlservices." In addition to more multistory and climate-control development, the stateof the current markets is also driving more retrofits.

"The trend we're seeing in construction itself is what some people are calling'in-fill' construction, where developers go back into urban neighborhoods and convertbuildings," says Digitech's Cooper. Keller expands: "Since people haven't beenable to buy new property, they've been looking to develop older property; and since it'smore urban areas than rural that people want to build in--at least in California--you'reforced to build multistory because of land costs. To go in and do an in-fill project orconversion can be a very smart move."

Fancy, Schmancy

"A study that we completed in the last year was of self-storage propertiesdeveloped over the past 36 months," Greenwald shares. "And we've found that thewell-located, better-designed properties were experiencing lease-ups significantly aboveaverage. A basic business premise is that in a market that becomes saturated, the only wayto increase your profitability is through market segmentation or differentiation." Asa result, developers are now looking at ways to differentiate their product in order torealize a higher net income.

What exactly does that involve? A greater emphasis on amenities, technology and design.Developers are being forced to pay greater attention to detail and aesthetics, but whetherthat is a product of zoning requirements, sophistication of the marketplace or customerdemand--or a combination of the three--is inconclusive. "Certainly developers arebuilding nicer and more attractive facilities these days, and the local ordinancescertainly have something to do with that," says Sentinel's Reddick, "but I thinkwhat really drives this trend is that building more attractive sites helps to drawbusiness."

One of the biggest trends we've seen in self-storage recently has been a maturation ofthe types of services offered. "Self-storage has become a more mature product, abetter-run product now that technology and security are married together inmanagement," says Cook. "Aesthetic treatments are also important now, primarilybecause of zoning. If you look at growth management, whether it's managed or whether it'sjust a perceived understanding of a community to a developer, there's a message given thata project must look a certain way."

RabCo's Owens expands, pointing out that the greater emphasis on aesthetics relates toself-storage as it enters a more retail environment. "We're now seeing a lot of nicefacades, Victorian looks, windows, different types of crown-molding features. There are alot more architectural demands than there have been in the past. A lot of it is due toPlanning and Zoning. Some of it is being dictated by the municipalities or approvalboards--if you pay big dollars for expensive ground in a retail area, they don't want itto have an industrial look. But some of it is driven by the owners' requirements. Theywant their project to have the curb appeal that will separate them from theircompetitors."

Is all of this really necessary? Well, the jury is still out on that. There arethose, like Pogoda, who are not convinced. "There is much more attention toarchitectural detail today, true; and a lot of that is forced on us. But the bottom lineis that--contrary to what people may think--the average tenant doesn't know thedifference. They want a nice, clean, attractive facility, but it doesn't have to be theTaj Majal. I think the trend that will continue, however, is one for more amenities, suchas climate control. That's where the demand is."

Argus' McCune agrees that some owners will tell you that the fancy accoutrements make afacility easier to rent. However, he also points out the effect this could ultimatelygenerate. "What's going to happen is that if you get into a price war, the lowestcommon denominator sets the price. So the guy who hasn't spent as much money is going toset the price. Some consumers are simply driven by price--their perception of value isdifferent. I'm not saying the amenities aren't important--they are. But there is a certainsegment of the market that is not willing to pay for them. The concept of high-qualityself-storage is more involved in the owner's mind than in that of the general public.Particularly in bad times."

Talking Tech

One trend that everyone agrees will persist as the year progresses is the addition ofmore technological features, including management software, security, payment options anduse of the Internet. "What automation and technology give you is convenience andservice and efficiency," says Cook. "Whether it's development, construction, oroperations and management, any way that you can use technology to provide a quicker pathto better service is a benefit. And the pressure will be there in the next year for you toautomate and use technology that will make things more customer-friendly, faster."

According to U-Haul's Vizcarra, "Technology is really playing the key role inhelping to differentiate the storage product. We're seeing a lot more climate-controlstorage, enhanced security and other features, such as credit-card or debit payments,etc." Reddick, who anticipates greater use of special features such as electronicfunds transfer, agrees, "Someone who is aware of the technology to help manage andprotect his facility is getting a leg up on his competitor because they are upgrading whatthey offer, enhancing their salability to the public. What we see in the upcoming year isa lot of upgrades."

Let's not forget to mention the ubiquitous presence of the World Wide Web and itseffect on this industry. "Obviously, the Internet is impacting everybody's businessalready," says Holsinger. "Marketing strategies are going to change simplybecause technology has changed. And where, in the past, we relied on the Yellow Pages--andit's still an important venue--it's use is somewhat decreasing as more and more people usethe Internet to access information."

Chiswell also stresses the importance of this indispensable cyber-tool. "I thinkwe'll see an even greater impact of the Internet on our industry in the next severalyears. The snowball gently rolling down the hill is starting to gain momentum already inthe buying and selling of cars and homes. Our industry will not be far behind. I envisionthe day in the next five to 10 years that new unit rentals, billing, collections andmarketing will all be primarily focused on a facility's Web site."

"In the next two or three years, the Internet capabilities and the like are goingto explode," adds Pogoda. "It's clear that's where things are heading. There'sjust no doubt about it."

It's All About the Money, Honey

In the end, questions regarding market saturation and site availability, multistorybuilding, climate control, architectural pomp or amenities will all be moot if the bottomline is not addressed: financing. Without funding, it is not a question of "If youbuild it, they will come." You just won't be able to build it. So do the expertsforesee any significant changes in the availability of funds? Not particularly, thoughthere is some skepticism as to how long the lending institutions will remain comfortablewith overbuilt markets.

According to Cooper, the financial markets on which self-storage will hold up andcontinue to be stable for some time. Holsinger, on the other hand, predicts a change."Lenders will eventually become aware of the real economic impact all the newdevelopment will have on long-term projects. It's easy to get financing when you have nocompetition within three or four miles of a major metropolitan city. But take Tucson, forexample: Now, there are almost 80 properties where, five years ago, there were 55. Thelenders putting money into these markets are going to get nervous because the stores arenot going to absorb the square footage as was projected. It usually takes lendinginstitutions a couple of years to catch up to what's really going on," he says.

Chiswell remains hopeful. "I think it may get a bit harder to find constructionloans as the year goes on, but I still see strong indicators for the first half of 2000.Because of the growth we have seen in the past five years, it's more critical than everfor developers to do their due- diligence homework on site selection, however. The daysare long gone when justification for a project was, 'I already own the land. How hard canit be?'"

McCune believes long-term financing is going to become much more difficult to obtainand banks will be frightened off. "The banks are still doing all of the developmentloans, and if they begin to realize that there's not good take-out money, they're going tobegin to tighten up, and that will slow development down. But for now, the pipeline isfull." He also feels there are fewer players than there were a year ago, which willresult in consequences for people attempting to refinance or wanting to sell properties,for example. "That's going to have an impact on the general liquidity of the realestate," he says.

Something else to consider is interest rates, which are presently rising; and accordingto Pogoda, if they continue to do so, it will prevent people like him from continuing todevelop. "My cost of capital would be too high, and then the cycle starts. When thateffect might come about, I have no idea, but I have to assume rates are going up andinvestors' needs for return are going to be greater than before. I have to adjust myprojections. Others should be doing the same, and if they aren't, I think they'refoolish."

Are we painting a grim picture? Not really--just a realistic one. But experts likeGreenwald are interpreting tighter financing and interest-rate increases as merespeedbumps, put into place to ensure the market doesn't overbuild as in previous cycles.Lenders are being more selective, and builders are required to conduct more comprehensivefeasibility studies, but this should, ultimately, be for the greater good of the industry.

In the End

Do we know, yet, what to expect from the self-storage industry in this supposed"new millennium," or will we, as some have predicted, stumble about inuncertainty and hope for the best? All signs point to continued success, as long as acertain degree of caution is maintained. Overall, it should be business as usual.

"The industry is so strong right now, so solid. I surely don't see any majorchanges coming this year," Pogoda admits. "I foresee the trends continuing forsome building, though I think it will slow down. I see the trend continuing for moreclimate-controlled space and more amenities at sites. I see it becoming increasinglyexpensive and difficult to find the kind of self-storage locations in the more developedmarkets that the pros really want to find. This is going to force people to be morecreative and explore other alternatives. But the industry is fundamentally very sound.Short of there being something catastrophic with the interest rates or the economy, whyexpect things to change dramatically?"

Others are more skeptical. "I think we're looking at a year of greatuncertainty," says McCune. "It's dependent upon the general economy. Any kind ofblip will have a significant impact, and I think that overbuilding in some markets is alsogoing to have an effect. And then I think financing is one of the biggest uncertainties,as it impacts the liquidity of the marketplace as well as value."

All things considered, experts are optimistic about what lays in wait for business thisyear. "I still feel that the development and ownership of self-storage facilities isone of the best entrepreneurial opportunities, not only in the United States, but aroundthe world," says Chiswell. "I'm still excited about our industry and itslong-term future."

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