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January 1, 1998

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State of the Industry

State of the Industry

Will the Boom Continue?

By Cecile Blaine

They say hindsight is 20/20. That's why we must look to thepast in order to anticipate the future. It is especially true in gauging the health of the self-storageindustry. Since self-storage is a real-estate function, it issubject to its business cycles, with few people actually agreeingon what part of the cycle we are in at any particular moment.However, we can look around us, to the past and to the present toanalyze where the industry is heading.

Since industry experts began recording statistics in the early'80s, we have been able to look at the development of theself-storage industry and identify cycles, trends, growth spurts,stable periods and downturns with accuracy. What is confusing isthat the various economic indicators of the industry aren'talways in sync with each other; they may even contradict eachother, with one area waiting to catch up to another. For example,new construction may be brisk, while rental rates and occupancyare leveling off or even dropping--as is the case with thecurrent business cycle. That's why determining the health of theself-storage industry can really only be an exercise in educatedguesswork--that is, until the year is behind us, and we havenumbers, figures and hindsight on our side.

Self-storage was officially born in the mid-'70s in thesouthern states, areas of the country teaming with multifamilyhousing, roving populations and few basements to storebelongings. Mainstream developers discovered self-storage as aninvestment in the mid-'80s. The word on the street was thatself-storage was tantamount to easy money; cheap land, easydevelopment, low overhead, few staff members and littlemanagement added up to excellent earnings in the eyes ofdevelopers. The result was a building boom that lasted severalyears with a number of newly converted self-storage gurus.

By the late '80s, however, a profitable, fledgling industrywas turning into a bloated, overbuilt one with high vacancies andmortgage payments and sagging rents. It continued into the early'90s, with the market finally hitting its lowest point ever from1990 to 1992, with many facilities across the country repossessedby lending institutions and the RTC.

Consumer demand eventually grows to meet supply in real-estatebusiness cycles, as it did by the middle of this decade, and themarket began to stabilize. The advent of REITs has led toincreased sophistication, a wealth of financing from Wall Streetinvestors, expansion of the typical facility and a hot market forexisting facilities.

Let's look at where the industry is today.

Occupancy Rates

According to the 1997-98 Self-Storage Almanac, nationalrental rates for 1997 dipped about 3 percent from 88.3 percent in1996 to 85.1 percent in 1997. Nevertheless, over a 10-yearperiod, the Almanac's 1997 rates are still nearly 5percentage points higher than 1988 figures of 80.4 percent.

When looking at that set of statistics only, it is easy toassume the industry is on the downside of the business cycle, butmany would disagree. Dave Cook, president of Tech-Fast of Tacoma,Wash., is one of those people. "I think that's a reflectionof the amount of inventory that's been brought into themarket," Cook says. "You can look at isolatedcommunities and areas of the country that...are overdeveloped,saturated. (However), development will shift to other regionsuntil that inventory can be occupied."

Still others say that the industry has overemphasized theimportance of occupancy. "That's the sacred cow ofself-storage," says Mike Burnam of Storage Trust Realty,based in Columbia, Mo. "We've got to keep our facilitiesfull. Why?"

Rental Rates

There are few national indicators of rental rates in thisindustry. According to the Self-Storage Almanac, rents onfive out of eight unit sizes fell in 1997 compared to 1996.Presented with these statistics, the chief operating officer ofone of the largest self-storage real estate investment trusts(REITs) is moved only by disbelief. "For a fact, I know theyhave not," argues Mike Burnam of Storage Trust Realty ofColumbia, Mo. "Ours have gone up 8 percent," from $7.01per square foot in the third quarter of 1996 to $7.69 in 1997.

Maurice Pogoda has a different perspective. As the presidentof The Pogoda Group in Farmington Hills, Mich., he says the manyprojects planned for his market this year are bound to pushrental rates down. "I don't see us being able to getanything but measly rent increases this year--if at all,"says Pogoda, who currently manages 19 facilities encompassing 1.2million square feet. "We eked out what we could last year,and we still have projects in the mid '90s. But there's apalpable sense that it's not as strong as it was in 1997. Itwasn't a dramatic difference, but as new projects come on line,it siphons off a little bit here and there."

Availability of Financing

One of the most prominent changes in self-storage in recentyears is the development of REITs and the resulting insurgence ofmoney available for financing.

Buster Owens of Rabco, the Ocoee, Fla.-based self-storageengineering and construction firm, says the amount of moneyavailable for construction is unprecedented. "Theavailability of money in the market to do construction is higherthan it ever has been," he says. However, it isn't justREITs that are flush with cash. Management companies are findingother sources for financing, such as pension funds, Owens says.

Pogoda has also seen the financing landscape changesignificantly in the 10 years he's been in business."Financing has changed so dramatically over the last twoyears," he says. "We've got financiers fighting overwho can give the lowest rates and the best interest."

The question then arises "How much is enough?" Toomuch money in the economy can fuel inflation and too much in theindustry can fuel a recession. Tech-Fast's Cook doesn't worryabout the abundance of funds in the system. "I don't feelthat it is out of control," he says. "I don't feel thatfinancing is so available that (lending) is done without goodjudgment. The due diligence that (our customers) go through iscertainly prudent and something I think is relatively sound.Financing is not free. It is available, but you still have toshow where that's a reasonable risk. Having gone through thecollapse of the savings-and-loan industry, that's not somethingthat people have ignored and forgotten."

Not everyone is so optimistic. "Instead of 80 percentloan-to-values, I'd still prefer to see 70 percent loan-to-value,where people have to know their business and they have to bewilling to put their money where their mouth is," Pogodasays. As he sees it, the current system "lets people open upfacilities that haven't done their homework."

New Construction

Storage Trust's Burnam sees only one direction for theself-storage industry: up. As good values in the market aregetting few and far between, the company is beefing up its plansfor new construction in 1998. Burnam says $10 million is budgetedfor in-house construction and $10 million to $20 million forjoint ventures.

Cook says the amount of business his company is enjoyingreflects a still-rising level of new construction. In fact, allof his barometers for business--inquiries, quotes, responses toadvertising and existing business--indicate that good times areahead. "The level of activity is still strong," hesays.

Rabco's Owens, whose customers include some of the largermanagement companies and REITs, sees a similarly sunny outlookfor the industry. The types of facilities he is building on theEast Coast are generally larger than in the past. "A lot ofthat is attributed to all of the REIT money in the market,"says Owens. "The availability of money in the market to doconstruction is higher than it ever has been."

Site Selection/Facility Design

The process of site selection has gone through its own cycleover the years, strongly influenced by REIT activity and theincreased legitimacy of the industry. When the industry firststarted, developers often chose sites that were out of the way,irregularly shaped or in some way unattractive. They could belocated in an industrial complex or have very limited streetaccess with most of the facility out of view. By purchasing theserelatively inexpensive, odd pieces of land, developers couldenjoy profits sooner. According to Owens, the REITs have uppedthe ante over the years--building on land that is much moreexpensive, much more attractive to other developers. "Whatthey are doing is paying premium prices for class-A sites,"says Owens. "Therein lies the big difference.

"It's not uncommon for Shurgard to pay $795,000 or$800,000 for a four-acre piece," Owens continues. "It'snot top dollar, but it's class-A exposure."

As a result, the definition of a "good site" haschanged, says Cook. "The difficulty these days is to findthat affordable site that can provide a return on theirinvestment in a location where there is demand--at a reasonableprice," he explains.

The type of site that larger developers are looking for hasn'tchanged, according to Burnam. "I still want my site to be inbetween Burger King and Taco Bell with McDonald's across thestreet, WalMart on the corner and a car dealership on the othercorner," he says.

Facilities themselves have become larger, by most accounts.One of the most recent differences is that, as a rule, developerswould build two-story facilities on expensive land in urbansettings. Now, some say, REITs will put up a two-story facilityalmost anywhere.

Economies of scale and more attention to efficiency by thelarger management companies may also explain the larger size,since those larger facilities offer the kinds of revenues thatwill pay for the property sooner than a small one. "You canspread your costs over more square feet," says Burnam."Therefore, you can afford to pay for that location."

But what about individual developers? They don't have thebankrolls that the REITs do. Pogoda says he has seen siteselection go full circle. "When I first got into thebusiness, a lot of facilities were being built in what we mostall agree are not great locations," says Pogoda, whoseclients are mainly smaller independents. "Then for a while,the pros were stepping in and building in the A-1 locations. It'salmost like the '80s all over again. We are seeing in our marketsso many people who want to get in on this self-storage thing thatthey've heard so much about. So, they are building in locationsthat I personally would not build in. So, it's almost come fullcircle--but only in a negative way."

With the growing competition from REITs, which everyone admitshas only made the industry stronger and more respectable, smallerindependent management companies must pay more attention tooperations. "If you are an individual developer, I stillbelieve in the need for phasing," growing only when theimmediate demand has been satisfied, says Owens. He also suggestsmore emphasis on curb appeal and meeting toe to toe with the bigguys on amenities, such as climate control, security features andother extras.

"Bells and whistles are going to go a long way," headds.

Facility Sales

One shortcut REITs can take in showing their investors animmediate profit--avoiding the construction phase altogether-- isby acquiring facilities. And they have been buying them up indroves. Storage Trust, for example, has more than $100 millionbudgeted for acquisitions in 1998.

"They have to show earnings immediately, especially withthe Wall Street money," Owens says. "They can't justspend this money just to spend it. It's got to pan out, becauseif it starts hurting their earnings, they'll probably take abeating on the open market."

With the wealth of funds available for purchasing facilities,it has been a seller's market for the past several years. As anexample, U-Haul has acquired approximately 150 facilities since1992, according to Carlos Vizcarra, vice president of storage andcorporate moves. The company has no specific budget foracquisitions for 1998, because as Vizcarra says, "We avoidrestricting our budget so as not to limit growth opportunity. Wewill look at any size property or portfolio anywhere in the U.S.and Canada."

Where Do We Go From Here?

Is national saturation and recession just around the cornerfor the self-storage industry? There are a few who see thecurrent financing situation as a sign of future overbuilding anda repeat of the late '80s and early '90s.

"Suddenly, what was learned from the S&L crisis andthe real-estate depression of the early '90s has been forgottenin 1997-98," says Pogoda. "It is very disconcerting.We'll probably bottom out a couple of years from now, whereaverage occupancy rates will be in the low- to mid-'80s."

Some recognize a downturn, but are not particularly alarmed byit. "I don't think that's a concern," says Cook."I think that's a natural cycle."

But the view from the top is clearly grand, with largermanagement companies and REITs not aware of any end to the goodtimes. U-Haul's Vizcarra says, "The health of theself-storage industry is contingent on continuing economic gains,and the future looks bright."

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