The Self-Storage Adaptive Reuse Model
- Feb 03, 2020
The self-storage sector has attracted a significant amount of investor attention over the last few years, but some markets are riper for returns than others. While this was always the case, it is even more so now that euphoria over the sector has led to overdevelopment in certain locations.
Most markets “are still dealing with the impact of high completion levels from the past few years,” according to the November 2019 Yardi Matrix National Self Storage Report. “The significant incoming self-storage supply continues to hinder rent growth nationwide,” with street rates falling 3.4 percent on a year-to-year basis for standard units, the report found.
At the same time, some areas are seeing a lack of available land zoned for new self-storage development. There is also rising government resistance to rezoning for its creation, since the asset class brings in less tax revenue and jobs than other property types. Some cities, such as Denver and New York, have gone so far as to enact local moratoriums on new self-storage development, which can further drive up the price of land in areas that are zoned for ground-up construction.
The key to achieving healthy returns is to find existing self-storage properties in locations where rates are still strong, or identify ways to create new opportunities if land prices are too high or development is not an option.
For example, Criterion Group recently received a $28 million loan to refinance a permit ready self-storage building in Long Island City, Queens, totaling approximately 257,000 square feet, which will be one of the largest self-storage facilities in New York City upon completion. Criterion is taking advantage of the neighborhood’s low self-storage occupancy rate, which is estimated to be well above 90 percent, with limited new inventory planned due in part to the city’s self-storage moratorium.
Readapt for Higher Yield
Other self-storage developers are readapting different property types to achieve higher yield. Larger industrial facilities and vacant big-box retail space are particularly well suited for reuse as self-storage facilities. In fact, some of the nation’s largest operators have become skilled at doing this, with several big-box retail locations being converted to storage facilities, according to Marcus & Millichap’s 2020 Self-Storage US Investment Forecast.
For example, Home Star Storage recently altered the type of self-storage facilities it plans to develop and invest in going forward. The company previously owned nine self-storage facilities along the Eastern seaboard from Vermont to Florida, but divested its cash-flowing facilities and turned primarily to adaptive reuse instead.
Home Star Storage was recently provided with a $7.75 million bridge financing loan it needed to quickly acquire and close the deal on a partially occupied property in Orlando within 30 days. The bridge financing allowed it to retrofit and transform the 55,000-square-foot property into an 810-unit state-of-the-art facility, while allowing time for the project to become fully leased up.
According to Yardi, South Florida remains one of the hottest markets for the self-storage sector. The region continues to draw downsizing retirees and professionals looking to live in a tax-friendly state, which in turn has supported an increased demand for storage space.
Risks and Advantages
Home Star pivoted toward adapting and reusing existing buildings and transforming them into climate-controlled self-storage facilities because of the potential higher rate of return. However, the strategy takes longer to execute, and is riskier than buying already existing and operating self-storage facilities.
When buying an existing facility is not an option, the advantages of readapting other property types versus new development are significant in terms of both time and cost savings. In general, it takes around two to three years to reposition and retrofit an existing building, versus the typical four to five years for new construction to reach stabilization, thereby greatly reducing carry costs. Construction costs are significantly less as well. Overall, developing self-storage as adaptive reuse versus ground-up construction can cut expenses by 30 percent or more.
For those contemplating similar opportunities, it is important to select a lender that truly understands the sector. Not all are the same, but those versed in self-storage investments understand the process needed to execute, how to perform cost valuations, the capital needed and how to build while still achieving a good yield.
Self-storage assets can take years to stabilize, during which time lease rates may decrease depending on overall economic conditions and local market competition. As such, it is important to understand the new construction pipeline and your competitors not only today, but also three to five years from now when a product is in lease-up. On the positive side, self-storage is an extremely stable property type: customers tend to lease for years, not months, and it is largely recession proof.
Several long-term demographic factors point to continued growth, including an aging millennial generation, according to Marcus & Millichap. The 80 million-plus millennial population makes up less than one-third of non-commercial self-storage renters, but that percentage is expected to rise as the generation enters its prime income-earning years. Private businesses, which represent a major part of self-storage demand, are also anticipated to make further use of these facilities in 2020 and beyond, as self-storage offers a more cost-effective option on a square foot basis compared with office or retail rents.
Of course, not all markets are the same, and developers looking to revamp existing product would be wise to drill down and look at sub- and micro-markets to determine where demand for self-storage is high, and supply limited. In general, self-storage facilities draw their customers from within a three- to five-mile radius, which means even in oversaturated markets there are likely to be some diamonds in the rough.
Billy Meyer is the managing director of Real Estate Lending at Columbia Pacific Advisors, a Seattle-based investment firm. Columbia Pacific Advisors Bridge Lending, a platform within the firm led by Meyer, serves commercial real estate clients nationwide. A fully capitalized bridge lender, it provides short- to intermediate-term loans ranging from $5 million to $75 million on a range of income producing properties including multifamily, senior housing, affordable housing, hospitality and self-storage.