Self-Storage’s Surging Profile
- Jun 07, 2016
The self-storage market continues to show strength, consistency, and an improving reputation with both equity investors and the capital markets. Rents are on the rise and occupancy levels remain steady. Underscoring these trends, in 2015 the leading self-storage REITs (Public Storage, Extra Space, CubeSmart, Sovran, and National Storage Affiliates) recorded year-over-year portfolio occupancy increases ranging between 40 to 320 basis points. Meanwhile, same-store revenue increased more than 6.5 percent.
On balance, self-storage assets present attractive investment opportunities for a variety of reasons.
• Life happens. The industry benefits from a variety of major changes that increase demand for storage space, such as marriage, divorce, new jobs and relocation, and more generally transient lifestyles.
• Home trends. As the home ownership rate and average size of living spaces continue to decline, rental housing is a popular option, especially in the urban core. Less living space translates into a greater need for storage.
• The REIT factor. Stepped-up demand from REITs is creating widespread liquidity and encouraging more developers to enter the field.
Rising rents, high occupancy and attractive returns on investment are sparking a healthy development pipeline. An estimated 600-plus new facilities are on track to come on line in 2016. New players are entering the sector, and existing developers are expanding their pipelines. Also of note is the hyper-local nature of self-storage markets. The typical trade area is no more than 3 to 5 miles, and developers are seeking higher risk-adjusted returns than are often available in conventional asset categories like office and multi-family.
Further, as the capitalization of opportunities tends to be relatively small, often too small for institutional debt and equity investors, cap rates remain in the 5 percent to 6 percent range. Further compression is possible for portfolios that reach sufficient scale. The trend of increased investment shows no signs of slowing as developers look to enter the market with multiple projects to capitalize.
Historically, local, regional and national banks have dominated the development and bridge loan opportunities for self-storage assets; CMBS has taken a large market share of non-recourse permanent opportunities. Debt funds, which often offer interest rates 200 to 400 basis points wider than those provided by banks, have recently started to win some of this shorter-term business, as borrowers try to steer clear of personal guaranties and maximize leverage to as much as 75 percent to 85 percent of cost.
Similarly, life insurance companies—which generally cap loan-to-value ratios for self-storage facilities at 65 percent—are maintaining an increased appetite for permanent non-recourse loans for stabilized self-storage facilities. Life companies generally offer more attractive interest rates, more prepayment flexibility, and easier, lower-cost closings than their CMBS counterparts. Ten-year CMBS loans might offer 4.5 percent to 5 percent interest and a 70 percent to 75 percent LTV. For a comparable deal, a life company might offer a 3.75 percent to 4.25 percent rate a slightly lower leverage point.
In addition, life insurance companies give borrowers the flexibility to lock in an interest rate for up to 30 years, as opposed to the 10-year term typically offered by CMBS programs. This increased liquidity is helping create a more attractive environment for owners, developers and investors—especially for higher-quality, climate-controlled facilities located in dense urban locations of major metro areas.
As the largest players in the self-storage space by a considerable margin, REITs exert a powerful impact. These players do much to shape and significantly affect the size, design and location of new facilities. REITs also typically operate with little to no debt, which allows them access to large amounts of unrestricted capital to pour into the self-storage facilities.
For smaller owners or developers looking to expand their portfolios rapidly, partnering with a REIT to manage their facilities is highly advisable. The sophistication and market intelligence of the REITs is unsurpassed, allowing them to efficiently lease and accurately price units and to provide enhanced owner returns. This also sets the stage for an attractive exit strategy as REITs seek acquisition opportunities from existing third-party management accounts.
The robust growth that the self-storage industry has achieved lately is a harbinger of its potential, and all signs point to continued momentum. The sophistication of the players, along with the improving quality of both the product and its management, is raising the confidence of both customers and investors. Besides attracting investors, this trend is helping win over local zoning authorities, a valuable trend as developers expand into dense urban locations. The favorable view of these stakeholders will encourage future growth and points to continued success for the sector.