Over the last 10 years, the self-storage industry evolved from a mom and pop investment class to a mainstream institutional asset class. The industry weathered the great recession and is now reaping the benefits of strong market fundamentals. Heading into 2018, I want to highlight some industry trends that will continue throughout the year and help the industry’s continued growth.
As we near the end of 2017, there are several signs that should capture your attention and point you in appropriate directions so you can capitalize on current market and economic conditions. From a big picture perspective, the first sign that should catch your eye is that cap rates may have reached their low point and could be ever-so-slightly on the rise. Meanwhile on the capital markets front, loan options have never been better (with the exception of construction financing). Digging deeper, here are some other signs you can look for as we wind up the year.
Over the last 12-36 months, the self-storage development train has been picking up steam and it is clear that certain markets are starting to feel the effects of new supply. Because this information is so critical to the ongoing success of the self-storage industry, Argus has worked in conjunction with other information sources and industry professionals to compile the most accurate development information in the industry. I want to give special thanks to Chris Sonne for his collaboration with Argus on this project and our efforts to provide the industry with the best possible development data available.
As indicated by the stock performance of the 5 self-storage REITs in 2017, the self-storage investment market is experiencing some headwinds. As we continue to see self-storage Net Operating Incomes flatten and deceleration of rental revenue, we are also experiencing areas of expense pressure including spending on advertising/marketing, payroll and real estate taxes. However, as the values of self-storage investments have flattened the demand for the investment in the private sector is remaining strong. We continue to see new supply coming on line and the impact of new supply could be higher in 2018 vs. 2017 reflecting multi-year lease-up of prior year deliveries.
Today the investment market for self-storage assets can best be described as having flat or softening values, but the demand remains strong. It is still a seller’s market, for now! Over the last 3 years, selling prices of self-storage properties have risen dramatically. A typical owner has seen their value (without any increase in rents or occupancy) go up by about 27%+; even more if your operating results improved. This large jump in value comes almost exclusively from cap rate compression of 150-300 basis points. These outsized gains in value over the last 3 years have resulted in the first wave of new development hitting the market. This, along with a few other headwinds will temporarily slow the pace of self-storage investment. Let’s take a look at a few things that will impact investment opportunities in the self-storage space over the next year and what you can do to stay competitive despite this potential slow down.
The self-storage acquisition market continues to be robust and we are seeing many new investors, both large and small, entering the space for the first time. However, the buyers today are a different group than the usual suspects of the last few years as many of the REITs and other household names are taking a more conservative approach to acquisitions in 2017. Because we have so many new buyers in the market place, I thought it might be helpful to review a couple of the necessary steps one must take to ensure a smooth transaction and complete a successful closing.
Since the beginning of 2017 we have seen the self-storage investment market change at a very rapid pace, most notably a greater dispersion of investment dollars throughout the country focusing on secondary market transactions that can deliver a higher risk-adjusted yield to investors. The reason for the changing market is that many major markets are showing signs of slowing property values due to new supply hitting the market, rising real estate taxes and flat to rising capitalization rates. These market tipping points have left a gap between the buyers’ and sellers’ expectations in the marketplace today.
Here at Argus, we spend a lot of time thinking and talking about the value of self-storage properties. That has been our business for more than 23 years; extracting the value of a property in the process of a sale for a seller, as well as helping buyers to determine the right price to pay for a property. Our daily conversations are usually focused around interest rates, cap rates, new supply, time on market, loan to value ratio, basis points, NOI and a lot of other tropics that rarely interest an owner other than when they decide to buy or sell a property. Owners typically avoid terminology such as this is because most owners are busy running their storage business and are not likely to sell anytime soon. However, we believe that there is a connection between understanding the current market and nuances of what does and does not create value and running a successful business.
Everyone has an opinion. This statement has always been true, but in today’s ultra-connected, social media-oriented world, opinions are much easier to share (and harder to erase). Why is this important to self-storage operators? The image that you project online is one of the primary reasons that people will choose to rent from your facility. The opinions shared on review sites, social media and even your own online Yellow Pages listing can tell a story about your business…and you want it to be a positive one!
Benjamin Franklin once said that “a penny saved is a penny earned.” The same holds true in the real estate business, except that we can expect an even greater return when we make an effort to save on operating expenses. At one time or another, we have all looked at our to-do list and thought “I can do that next month.” Reviewing your operating expenses, however, is not one of those things you can afford to put off until next month.
The last few months of 2016 saw some interesting changes. We had a historic presidential election, the ten year treasury moved up in a meaningful way, and Self-Storage REIT stock prices sagged for the first time in quite a while. Meanwhile, the phone at Argus has been ringing off the hook with owners wanting to find out what their property is worth. In some cases, their interest is only curiosity, but in many cases they are interested in financing, real estate taxes, estate valuation or selling.
The holidays are upon us and cautious optimism is certainly present in today’s real estate market, including self-storage. The recent presidential election along with the softening of the self-storage REITs operating data has momentarily caused the market to pause as many investors and financial institutions, both big and small, are pulling in the reins and exercising discipline. The ten year treasury has been gradually moving up from a low of 1.37% in July to over 2.4% in early December, with the largest jump coming just weeks after the presidential election.