Self-Storage Real Estate in 2023: Where We Are Now and Likely Headed This Year

The self-storage industry has proven that it’s less sensitive to economic shifts than other real estate sectors, not only during the pandemic but throughout multiple economic contractions over the past few decades. During the great financial crisis of 2008 and 2009, for example, loan defaults were virtually non-existent in self-storage and among the lowest of all commercial real estate asset classes.

The business certainly proved its resilience as the pandemic took hold. There was an increase in demand as “work from anywhere” opportunities drove people to create home offices or relocate. This resulted in higher rents and double-digit revenue, despite the economic upheaval caused by lockdowns.

In the first few months of 2022, we experienced the “perfect storm” of events to create a white-hot market—perhaps the most aggressive market in terms of volume, pricing and activity. During the first and second quarters, leasing demand remained elevated, producing strong store-level revenue and net operating income (NOI). The low-interest-rate environment coupled with high investor confidence led to record low yields, and the combination of these factors led to record pricing.

According to research conducted by my firm, 2021 self-storage investment sales volume was a staggering $23 billion, much of which was recorded during the last three months of the year as several multi-billion-dollar transactions closed. (In contrast, sales were only $1.1 billion in 2012.) This strong showing carried over into the first half of 2022, with more than $6 billion in sales.

In March, the Federal Reserve raised its benchmark interest rate for the first time since 2018 and began signaling more raises to combat high inflation. These interest-rate hikes have greatly increased the cost of financing and led to meaningful hits in the equity, bond, private-equity and commercial real estate markets. Currently, there are fewer self-storage deals on the market due to pricing uncertainty. Buyers are factoring a higher cost of capital in their underwriting while trying to solve to the same return metrics. Meanwhile, existing owners are happy to hang onto their assets, as the fundamentals are still strong, and they’re clipping great returns from cash flow.

Consider the self-storage real estate investment trusts (REITs), which are an excellent source of industry data. Due to their shareholder reporting requirements, they help inform the general trajectory of the sector. At the end of 2021, occupancy rates for the top five REITs—CubeSmart, Extra Space Storage, Life Storage, National Storage Affiliates Trust and Public Storage—were around 94.5%, reflecting positive tailwinds from COVID-19. (As a reference point, year-end 2019 occupancy stood at an average of 91%.) Higher occupancy resulted in increased rents. In fact, rates are at an all-time high, increasing revenue for all reporting REITs by 14% to 22% for the year-over-year period ending in the second quarter.

The Impact of Inflation

Inflation has been running strong, with the August 2022 Consumer Price Index report showing 8.3% year-over-year growth for all items. Fortunately, given the self-storage industry’s month-to-month lease terms, owners have been able to pass their increased operating costs to customers. Further, as housing costs have risen, consumers have been tolerant of higher storage-unit rental rates.

The improved revenue at our properties should also drive more development. Developers are generally focused on yield-on-cost metrics and, if all else is equal, these look better as rental rates increase. However, we’ve also seen higher construction costs, which could slow activity in the near future. More than 60 million square feet of space was added to the market between 2018 and 2020, but only about 50 million is expected to be added between 2022 and 2025, which is just 3% of the total inventory.

Oversupply is the greatest risk to the market, and that seems unlikely to be a near-term problem. The combination of logistics, labor shortages, higher interest rates and a pullback of capital all make development riskier, so the construction pipeline will continue to be muted. This offers great protection for current self-storage owners and developers who are able to make a deal pencil out.

Looking Ahead

Self-storage has always been a need-based business. Whatever a customer’s life circumstance—divorce, downsizing, death in the family, etc.—the need for space is ever present. It’s expected to remain a valuable asset class in the coming months and years due to:

In other real estate classes such as office and retail, owners need to put substantial money into their assets and pay high commissions to attract tenants during economic downturns, signing long-term leases at the bottom of the market. By contrast, self-storage owners can adjust rents upward as the economy recovers, with no down time in the revenue stream.

This consistent durability of self-storage continues to draw investor capital and boost property values. However, going forward, owners and investors will need to adjust their return parameters around the higher cost of capital. Existing cash-flow properties are still performing, and lease-up properties continue to operate at or better than their pro formas; however, the options to refinance or sell are changing given the Federal Reserve’s decision to raise its benchmark rate. This activity has a direct effect on borrowing costs, which impacts what buyers can pay for properties as well as direct opportunities.

Still, even as financing gets more expensive, investor appetite for self-storage remains robust. Both public and private sources of equity and debt capital continue to be attracted to the industry’s resiliency, steady cash flow, mark-to-market ability and low capital-expenditures requirements. The challenge is debt providers are more selective given the current rate of inflation and economic uncertainty. Interest rates will continue to drive up costs and keep asset values consistent. Soft and lease-up costs have also become more costly.

While there remains an active buyer and seller pool, transaction volume will remain slightly depressed relative to recent record levels until there’s better clarity on interest rates and the overall economy. This “bid-ask” gap—where sellers and buyers are valuing their assets differently—is a common occurrence in any period of market volatility. It may disappear in months, or it could take longer to play out. But this isn’t isolated to self-storage, which looks likely to continue its history of outperforming the broader market.

Steve Mellon is a managing director and leader of the national self-storage group for JLL Capital Markets, a global provider of capital solutions for real estate investors and occupiers. Specializing in self-storage acquisitions and dispositions, he’s been involved in $2 billion in property sales and structured financing/equity placement. He also consults with clients on ways to boost property value. Mellon has been a speaker at self-storage events and contributes articles to industry publications. To reach him, call 713.425.5835; email [email protected].