Speaking to a panel of real estate professionals in the 1980s on the dangers of overbuilding during a period of economic expansion, Dallas real estate magnate Trammell Crow offered lenders in the crowd a simple proposition: “If you stop lending, I’ll stop developing.”
Thirty-one years later, the nature of that relationship has manifested in the Texas self-storage market. After minimal delivery of self-storage properties in 2012 and 2013, development began to surge in 2014. The Texas Self Storage Association (TSSA) estimates that there are now roughly 6,500 facilities statewide, and local sources concur that unit growth from 2014 to the present has been somewhere in the neighborhood of 350 new facilities per year.
This development boom has occurred in the face of rising land prices, high property taxes and a constricting pool of skilled labor that has driven up construction costs.
Overall economic growth is contributing to the concern as well. Lenders are still lending, thus developers are still developing, betting that the pent-up demand for self-storage properties in Texas still has some gas left in the tank.
The bullish perspective on self-storage appears to go beyond the Lone Star State. Tennessee-based hotel data and research firm STR, which has begun monitoring the self-storage sectors of major MSAs, notes that there are 840 new facilities under construction nationwide across the 25 largest markets. Though the company does not expect all of these projects to come to fruition, if they did, total supply would increase by a whopping 7.7 percent year-over-year.
The self-storage professionals interviewed for this story differ in their views on how much new supply the market can bear. But all agree that the current wave of new supply is a big one, and that regardless of whether or not it creates an overbuilt market, positive rent growth in major markets is highly unlikely in the short term.
Hard Numbers
STR is currently tracking 230 self-storage projects in some stage of development across Dallas, Houston and Austin. More than 110 million square feet of net rentable space already exists in those markets, with overall occupancy rates in each metro hovering around 85 percent.
Dallas is spearheading the charge, accounting for 140 of those 230 projects despite the fact that its overall market size is slightly smaller than Houston’s in terms of net rentable square footage. STR estimates that 27 of the 140 Dallas projects will eventually get off the ground, increasing the size of its self-storage market by 4.9 percent.
Facilities in the Dallas pipeline are also getting larger, totaling as much as 80,000 net rentable square feet across 820 units on average, according to STR. The largest onr in the Dallas area, ALL Storage — Marine Creek, opened in Fort Worth earlier this year and offers 211,000 square feet of net rentable space.
Clark Edgecomb, Edgecomb & Associates
In Houston, the tendency for vertical development is more pronounced.
“In addition to developers spending more on appearances and amenities, we’re seeing a lot of development within infill, urban locations in Houston,” says Clark Edgecomb, president of architecture firm Edgecomb & Associates, which designs self-storage properties. “This means going vertical.”
Edgecomb’s firm recently designed a six-story facility for Proguard Self Storage in Houston’s Medical Center district. Featuring 178,000 net rentable square feet and roughly 1,750 units, the project speaks to both the verticality and big-footprint trends within the Texas market.
Robert Loeb, president of SurePoint Self Storage, notes that in 2006, developers frequently built facilities in the 90,000-square-foot range that offered about 70,000 net rentable square feet . This trend of getting bigger is tied to rising land and construction costs, which are forcing developers to disburse those expenses over more units. The longtime self-storage owner and developer is among those who believe the Texas market is moving toward oversaturation, with the Dallas market embodying the problem.
“You can look at Dallas and say, ’25 percent of the market is being added to the existing supply — that’s too much,’” says Loeb. “And it is. But that doesn’t mean you can’t find a site that will work.”
Loeb’s analysis reflects an old adage of self-storage: it’s a three- to-five-mile business, meaning most of a facility’s business comes from the surrounding neighborhood, thus a high degree of variance exists from submarket to submarket.
Still, several years down the road, the overbuilding is likely to drive occupancies down to 40 or 50 percent in newer Texas facilities, Loeb predicts — not that this possibility will deter continued development.
“As long as developers can get money, they’re going to build,” he says. “My guess is that unmet demand has been met by supply and that we’re in the process of moving toward oversupply, and some people are going to get hurt.”
Robert Loeb, SurePoint Self Storage
REITs Feel the Strain
The National Association of Real Estate Investment Trusts (NAREIT) reports that total returns for the six publicly traded self-storage REITs it tracks — Public Storage, CubeSmart, Extra Space Storage Inc., Global Self Storage Inc., Life Storage Inc. and National Storage Affiliates — are down 2.6 percent as of May 31, 2017. This figure represents a 4 percent decrease in total returns from the same period in 2016.
“The REITs can’t continue to post growth in net operating income (NOI) of 8 or 9 percent with all the new supply,” says Loeb. “Now they’re looking at 3 or 4 percent growth, and Wall Street doesn’t like that kind of deceleration in earnings.”
According to Ginny Sutton, executive director of the TSSA, the struggles of the REITs are tied to supply-demand imbalances and the subsequent impacts of those disparities on rents and occupancies. Because REITs operate in major markets across the country, this correlation suggests that the heavy level of self-storage development is not unique to Texas.
“Stocks of REITs have declined over the last six months and their occupancy rates probably have too,” says Sutton. “The overall performance of the REITs is definitely related to new supply.”
Ginny Sutton, Texas Self Storage Association
Sutton notes that while the flagging REIT stocks have not triggered panic from investors, their performances indicate negative rent growth is imminent.
Compounding this problem is the REITs’ general desire to achieve high occupancy shortly after opening new facilities. This mode of operating frequently prompts REITs to offer move-in specials and other types of discounts or concessions, which smaller properties feel compelled to match, further driving down rental rates.
Though Sutton believes the Texas market as a whole has not reached the point of discounts and concessions, she holds that the state’s major cities are at the “tipping point” of being oversupplied. Without the rampant population growth of recent years, they’d likely have crossed that threshold by now.
Financial Backlash
With their stocks struggling, self-storage REITs have been relatively quiet on the acquisition front in 2017, opening the door for smaller institutional investors, as well as private individuals and 1031 exchange buyers, to snap up properties.
Despite the emergence of a different type of buyer pool, overall investment activity hasn’t changed much in the wake of the development boom. Financing for acquisitions remains highly accessible in a low interest rate environment, with lenders still interested in working with private buyers.
“Storage lenders are using more stringent underwriting standards when evaluating a construction loan because of how much new supply is coming on line,” says Michael Johnson, principal at self-storage brokerage firm Bellomy & Co. “They’re asking themselves, ‘How can I underwrite year one and year two rental rates and growth when there’s a 100,000-square-foot competitor opening up down the street?’”
More players are joining the game, lenders are scrutinizing new projects more carefully and the level of inventory saturation varies tremendously from submarket to submarket. Collectively, these factors have upped the ante on being in the know, says Johnson.
“Whether you’re a lender, developer or broker, now more than ever, you have to be up to speed on who’s building what
Michael Johnson, Bellomy & Co.
and where and when it’s going to come on line,” he says “Because it’s going to affect underwriting standards and rental rates.”
Johnson adds that in his view, it will take another 18 months to determine if the market is overbuilt, and that, per usual,
it will vary from pocket to pocket. But he firmly believes rent growth will be flat, if not negative during that stretch.
A Glass Half Full
Though he shares the general sentiment that degrees of oversupply will vary considerably from submarket to submarket, broker Bill Brownfield sees the current volume of development across the Texas market as a whole as generally in line with demand.
Brownfield, the owner of Houston-based Brownfield & Associates LLC, broke into the self-storage industry in 2008 as an investor. Since then, Brownfield has closed more than $200 million in self-storage deals, and recently began compiling his own data on the sector in Texas markets.
“Texas as a whole is close to equilibrium, tilting slightly to still being undersupplied at the moment,” he says. “Drilling down to individual markets is a different story.”
Brownfield points to the performance of Public Storage, a REIT representing approximately 20 percent of the market
Bill Brownfield, Brownfield & Associates
share in Houston and Dallas, where its facilities have posted an average 90 percent occupancy rate. Historically, occupancy rates for properties in these markets have stabilized around 85 percent.
“The performance of Public Storage is a fair proxy for those markets,” says Brownfield. “At the same time, occupancies
in secondary or tertiary markets across Texas remain above historical norms.”
So while major markets are absorbing the brunt of the new supply, smaller markets could rent growth return to 3 to 4 percent per year, in Brownfield’s estimation.
— By Taylor Williams. This article first appeared in the August 2017 issue of Texas Real Estate Business magazine.