Self Storage Financing: How to Survive a Recession
- Aug 28, 2019
Self storage has a reputation as an asset class that could weather a market downturn, in large part because of its ability to produce consistent cash flow. Nonetheless, investors should take care to avoid excessive risk and carefully assess financing options that can keep them above the water when conditions become challenging.
Peter Margolin, a commercial loan originator at Alliant Credit Union, recently offered insights on the self storage sector and discussed the asset category’s vulnerable points, as well as the impact of a potential recession.
What are the biggest challenges in the self storage financing landscape?
Margolin: The self storage business provides consistent cash flows and revenue, making it attractive to both private and institutional investors alike—but it’s almost too good for its own good. Since seemingly everyone wants to be in self storage, overdevelopment is probably the biggest challenge right now, not to mention the highly competitive financing market as transaction activity has diminished in the face of economic uncertainty.
What are the top three trends in self storage financing?
Margolin: First, we’re seeing more amenities and specialized spaces—things like wine storage, full climate control and safe deposit boxes. Second, I’d point to the trend of heightened security measures around self storage. This includes features such as Category 5 hurricane proofing and customized security systems that can be accessed through a smartphone application. Finally, self storage providers are adapting their properties for Millennials, who tend to live in smaller spaces. That might mean, for example, providing on demand pickup and delivery services.
There’s an ongoing debate that we are approaching a downturn. How can self storage investors prepare for a recession?
Margolin: My biggest advice to self storage investors is don’t overleverage your properties. As it stands now, most property owners are not falling into this position. They are locking their long-term debt in at reasonable levels. If a recession hits, they can still make their payments. As for self storage operations in a recession, it is actually possible that the self storage market can benefit, because when people downsize their house or need to move locations, they tend to rent out self storage spaces in their transition. One thing I will say is to know your market—carefully assess the competition to make sure the market will not be oversaturated if there is a downturn.
In the case of a recession, what are the underlying risks of self storage investment?
Margolin: The biggest risks for self storage investment during a downturn are overleveraging and full-term, interest-only deals. In a market with declining values, there’s limited liquidity, so if you overleverage yourself by taking on a loan with no flexibility, foreclosure becomes a very real possibility. Self storage investors can survive a downturn by entering into loans that are retained on a lender’s balance sheet and can be modified in response to adverse circumstances.
Investing in Opportunity Zones has become increasingly popular. How is this trend impacting the self storage landscape?
Margolin: Within Opportunity Zones, self storage owners are getting outbid by developers who want to build property types that bring in more revenue, such as multifamily and retail. While new building of a self storage facility is typically allowed, a new property won’t qualify for Opportunity Zone benefits if another self storage property already exists in the zone. The federal language on Opportunity Zone policy simply doesn’t allow it. Investors are conducting market surveys to know if their project will even receive the benefits within an Opportunity Zone before they can consider building there.
How have the needs of self storage borrowers changed in the last few years? What do you expect going forward?
Margolin: The needs of self storage borrowers vary depending on whether they are financing a new development or an existing asset. Generally, self storage borrowers are seeking long-term loans of five, seven or ten years rather than short-term loans. As the risk of a downturn looms closer, investors should choose their lender carefully. Should the market turn in an unfavorable way, you want the backing of a relationship lender who wants you to succeed. They’ll be more willing to offer a loan restructuring if things get rocky, rather than simply repossess the property.