Strong User Demand, High Returns Keep Self-Storage Buyers Hungry
The self-storage industry started its upswing during the Great Recession as more and more Americans turned to storage units as a result of being forced to downsize or foreclose on their home, recalls Alec Pacella, president with NAI Pleasant Valley in Medina, Ohio. “That’s when the industry sparked, but it’s never stopped,” he says.
There are three main reasons that the self-storage sector has continued to perform well as a commercial real estate property type, according to Pacella. First, an increase in consumer spending has left Americans with more goods to store. Second, there’s been an influx in larger institutional investors and regional aggregators looking to acquire self-storage properties. Lastly, the advent of technology has enabled operators to run properties remotely and offer services such as automatic payment systems and 24-hour access.
While the industry has long been dominated by the local mom-and-pop type operators, there are examples of regional players expanding their portfolios today. One such company that Pacella cites is Valley Storage, which has entered the Ohio market from its headquarters in Maryland. The company now has five locations in Northeast Ohio in addition to facilities in Pennsylvania, Virginia and North Carolina.
The supply of new self-storage units has consistently outpaced demand since the beginning of 2017, says Cody Bond, associate economist with Reis. Supply growth has slowed in comparison to last year, but Reis still expects roughly 280,000 units to come online by year-end.
Demand was noticeably weaker in the third quarter of this year, with only 4,000 units absorbed nationwide, according to Reis. This figure is dramatically different from the recorded net absorption of 30,000 and 20,000 units in the third quarters of 2018 and 2017, respectively.
“We expect the pipeline of new self-storage to slow in 2020 and beyond, although it will likely take a few years for the self-storage market to stabilize,” says Bond. “Despite being noticeably weaker than in previous years, demand is still positive for the year and likely will be for the years to come.”
Positive demand trends coupled with favorable yields keep self-storage buyers active, according to Marcus & Millichap’s outlook report for the second half of 2019. The added supply has put downward pressure on rents, however, as the average rent for a 10-foot by 10-foot, non-climate-controlled unit was expected to drop 0.9 percent to $1.15 per square foot this year.
Eyes on the price
Initial returns for self-storage can exceed those of other property types, argues Marcus & Millichap. In particular, the Midwest experiences some of the highest initial yields with an average cap rate of 7.2 percent. By comparison, the average cap rate in the western region is 6 percent and in the Northeast it’s 6.5 percent.
Brett Hatcher, a senior vice president of investments and a senior director with Marcus & Millichap’s National Self-Storage Group, says he believes that the amount of capital pursuing self-storage is at an all-time high. He identifies the majority of buyers he works with as experienced self-storage owners, ranging from regional buyers with a couple of properties to private equity firms looking to deploy $100 million or more.
This year, Hatcher assisted in the sale of a newly constructed EZ Storage property in St. Louis for $9.2 million. An undisclosed, national REIT purchased the facility and was attracted to the Class A building because of its size, says Hatcher. The property, encompassing 751 units and more than 77,000 net rentable square feet, sold in less than 60 days after going to contract.
Ryan Clark, director of investment sales for Tampa-based SkyView Advisors, says that his team runs a highly structured process to ensure sellers receive the highest price and best terms the market will bear by engaging with a broad spectrum of potential buyers. “During 2019, we have sold deals to small local owners, high net-worth individuals, family offices, private equity firms and publicly traded REITs,” says Clark.
That said, Clark points out that the majority of purchasers are private equity-backed buyers or publicly traded REITs. Private equity buyers tend to hold their acquisitions for five to 10 years, while the REITs hold their assets for the longest period of time, he says.
Clark recently represented the seller of a 70,914-square-foot Select Space Storage facility in Prior Lake, located in metro Minneapolis. CubeSmart, a self-storage REIT, purchased the 3.5-acre property.
As of Sept. 30, CubeSmart’s owned and managed portfolio of properties totaled 1,171 buildings. The company has completed $3.1 billion in acquisitions since 2010. CubeSmart says it has “a disciplined growth strategy of investing in targeted markets to maximize risk-adjusted returns.”
Clark says that the self-storage asset class “will continue to experience growing interest from institutional capital, which will result in active deal volume throughout 2020.” At the same time, new supply will pose challenges to leasing velocity and rental rate growth. This will require operators to spend more money on advertising to drive traffic to their properties, argues Clark.
Quick to react
When considering a property for purchase, buyers don’t place much emphasis on what operator is in place at the time of sale, according to Pacella. This is because buyers will come in with their own branding and marketing. In Ohio, Pacella says the majority of deals average between $500,000 and $2 million.
In Pacella’s eyes, Class A facilities that earn top dollar are fully paved, well lit, attractive and clean and also offer a variety of units and services. The catch is that consumers aren’t very willing to pay more unless the property offers something really amazing. “The nicest facility I sold was only getting $5 more [per month] in rent than the facility down the street that was kind of a dump,” says Pacella. “It’s hard to get a premium.”
What is advantageous for self-storage owners is that most leases are 30 days, so landlords are able to react quickly and adjust rental rates if necessary, says Pacella. For this reason, he believes 2020 will be another solid year for the property type. “Even if there is a downturn and owners sense softening, they can react quickly by pulling back rents,” he says. This ability is a great advantage over other property types that have yearly leases.
The other factor to remember when forecasting the self-storage sector’s performance in 2020 is that it is a consumer-dominated industry, Pacella points out. The vast majority of renters are consumers as opposed to corporations, so a slip in consumer spending could cause a hiccup in the self-storage market. “But I don’t foresee that occurring, at least in the first half of the year,” says Pacella. “I’m confident in the industry because it can react quickly.”
— By Kristin Hiller. This article originally appeared in the December 2019 issue of Heartland Real Estate Business magazine.