Halfway through a year of transition, the self-storage sector continues to undergo changing investor dynamics while feeling the effects of political uncertainty in Washington. Yet opportunities abound, particularly in the Midwest, where a moderate development pipeline has kept supply in check with demand.
We’re currently witnessing a pool of buyers rethink their approach amid rising interest rates and a lack of tax and policy guidance. As a result, large self-storage real estate investment trusts have tempered growth expectations as development activity puts upward pressure on vacancy, and rent growth moderates. This may present an opening for small to midsize buyers to enter the market or expand their existing portfolios.
Joel Deis, Marcus & Millichap
Meanwhile, sellers are looking to capitalize on elevated valuations. Yet, the climate of higher interest rates will likely bring lower cash-on-cash returns and put upward pressure on cap rates.
Favorable fundamentals
Nationwide, self-storage is currently downshifting to a more sustainable growth trajectory after years of rampant expansion. Newly employed millennials are finally moving out on their own, spurring household formation. Baby boomers are also leaving the family nest as they look to downsize. These societal shifts, along with the current economic landscape, are driving a demand for space and keeping vacancy rates stable.
Like household formation, retail sales are also on the rise, bolstered by steady job growth, higher wages and rising consumer confidence. With these purchases comes a need for storage, contributing to the sector’s gains.
The continued popularity of the rental lifestyle, which has proven attractive to millennials and baby boomers alike, will also have a positive impact on self-storage, as apartments typically do not offer enough space to house all of a resident’s belongings. Developers are anticipated to deliver 371,000 apartments across the country in 2017, the greatest supply addition since the mid-1980s. What’s more, apartment sizes are shrinking. According to a RentCafe report from last year, the size of the average new apartment unit in 2016 was 934 square feet, down 8 percent from a decade earlier.
Build it and they will fill it …
The delivery of new facilities will outpace storage demand in 2017 causing some softening in occupancy. The national vacancy rate is projected to move up 80 basis points this year to 11.1 percent.
Owners are expected to see a continued rise in rental rates. This year, the average rate for a climate-controlled space will climb 2.4 percent to $1.62 per square foot, building on a 1.6 percent increase in 2016. Rates for non-climate-controlled units will increase 2.6 percent to $1.31 per square foot, following a 3.1 percent gain last year.
In the Midwest, construction activity is steady but not excessive, insulating the region from the wave of development impacting other parts of the country. Driven by improvements in the Ohio and Missouri markets, the Midwest vacancy rate is projected to rise just 30 basis points to 12 percent, the smallest vacancy increase among all regions. Cleveland will see the region’s biggest decline in vacancy, which is expected to tumble 60 basis points to a seven-year low of 9.7 percent.
However, solid vacancy performance has yet to translate into significant rent gains in the Midwest, where rates are forecast to rise roughly 2 percent this year, lagging the national average. A notable exception is Indianapolis, which is on pace to record one of the strongest rent increases in the country due largely to limited construction and historically low vacancy. Minneapolis is another market expected to post rent growth above the national level, though rising vacancy will moderate gains from last year’s healthy pace.
… but for how long?
The self-storage sector has seen an incredible run of vacancy compression since the Great Recession, so 2017 marks the start of a return to normalcy. Although vacancy is expected to moderate this year, it will remain near a historical low, leaving plenty of runway.
Looking ahead, the outlook for self-storage is favorable despite some healthy caution. Lending is softening in development-heavy metros, but this selectivity should propel financing of quality projects in high-demand areas that will allow the sector to continue its run, keeping storage units across the country as full as the boxes they house.
Joel Deis is national director of self-storage at Marcus & Millichap. Deis also serves as regional manager of the firm’s Seattle office.