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November 1, 2007

5 Min Read
Real Estate Roundup

The industry has been abuzz with uncertainty in the real estate markets for the last several months. In this high-stakes game of musical chairs, now is the time to find a seat before the music stops, bringing to an end high real estate prices and easy financing. This is the time for serious analysis of your personal objectives and options before real estate and credit markets severely limit your options and outcomes.

By most measures, the self-storage business is reasonably steady, if not booming. Rental rates are still going up but at a more modest rate, and occupancies appear to be holding steady, often at the expense of more concessions. But the reality is self-storage owners are also in the real estate businessand in a big way! Unfortunately, the term to describe the real estate aspects of our industry would not be stable, and most real estate professionals would probably not use the phrase positively inclined for the foreseeable future.

Many of you are aware of the debacle in the residential finance market (particularly after reading other articles in this issue). But I was somewhat surprised to find that storage owners are also awareand some actually predictedthat many of the same things are happening in the commercial real estate market. We recently asked 22,000 facility owners to share their opinions in a survey about the industrys future. This is what we learned:

  • Ninety-one percent thought cap rates would rise at least 1.5 percent by June 2008.

  • Seventy-three percent thought interest rates would increase 1.5 percent by June 2008.

  • Fifty percent predicted capital gains rates would increase by 10 percent.

This survey was taken before the credit crunch became a prime-time headline. Interestingly, more than half of the respondents also thought there'd be more competition and a recession by June of next year. The intuition of self-storage owners proves to be acute and predictive of future trends. For what it's worth, I think there's a high probability that survey respondents are going to be spot-on regarding cap rates and interest rates.

Whats the Big Question?

The real question is: What do rising interest rates and credit availability, as well as increasing capitalization rates, mean for self-storage owners and their property values? In other words, how do changes in the macro economy and credit markets impact the value of self-storage properties and owners flexibility?

Cap rates (the way self-storage and other commercial real estate is valued) and interest rates are inexorably linked. If interest rates go up, cap rates will ultimately go up, and vice versa. However, due to various market conditions, the link between the two is somewhat flexible as to timing and magnitude. Think about the relationship between the two rates as being tied together by a short rubber band that allows the relationship to expand and contract somewhat, while the overall relationship remains very strong and close.

What Is Happening to My Value?

If your property is stabilized, its value is probably going down; but the good news is its still worth more than at any time in the last 25 years, except for the last nine months. Cap rates have slightly moved up because of increased interest rates and the perceived risk, but they still remain at historically low levels (remember, low cap rates mean high values).

An example may help explain the mechanics of the numbers. Assume we have a property generating a net operating income of $200,000. At recent cap rates for high-quality properties, the value would be about $2.67 million; if cap rates go up 1.5 percent as suggested by owners in our survey, the new value would be $2.2 million, a 21 percent decline in total value. However, if the property were to be financed at 75 percent of the first value, equity in the property would decrease 70 percent.

If youd like to test the sensitivity of your own project, you can download a worksheet that will help you understand the pricing model and definitions as well evaluate the impact on your property from www.selfstorage.com/argus/sensitivity.pdf.

What About Refinancing?

While interest rates, loan availability and amounts have become less certain in recent months, rates are still in the lower end of the historic spectrum, and loans for stable properties are available. If youre holding the property for the long term, its a very good time to make sure you have a fixed-rate mortgage with a term of at least three years and preferably not less than five years. Having a remaining term on a good loan ensures against difficult credit and high-interest rate periods in the market. If you carry credit stress, refinancing can be very costly and even catastrophic in serious crunches, as it was in the 1980s.

To carry our musical chairs analogy a little further, if your objectives are to hold your facility for the long run, you might consider the refinance chair. Its essential to make sure you have financing with a significant remaining term and a fixed interest rate operations can support. If, on the other hand, you have any thoughts about selling in the next three to five years, or if significant competition is entering your market, you may want to find a chair that accommodates accelerating your selling decision to avoid rising cap rates and a lower price.

Whichever chair you choose, make sure you are certain of your objectives. The music is about to stop for a while, and you may as well sit comfortably until the market returns to playing a more lively tune.

Michael L. McCune is president of the Argus Self Storage Sales Network, a self-storage real estate brokerage and development company based in Denver. Argus also operates www.selfstorage.com, a marketing medium for owners in the self-storage industry. For more information, call 800.55.STORE; visit www.selfstorage.com.

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