The first few months of 2020 have seen the capital flow of both debt and equity increase, but there is a significant bifurcation in the self-storage investment market in valuations between stabilized assets and newly developed assets in lease up. Today, stabilized assets are commanding all-time high pricing while newly developed lease up properties are experiencing some softening in pricing. This is reinforcing the fundamental fact that self-storage is still a cash flow business and 90% of value is created by your NOI and free cash flow. This is largely driven by the current debt markets and the investment community’s strong desire for yield and assets with low capital expenditures, such as self-storage.
As we enter this new decade in 2020, Argus is celebrating its 26th year in business. In that time, we have learned a great deal about what makes a successful self-storage investment. We have seen a lot of changes in the self-storage industry over these 26 years, most notably the tremendous expansion of more than 20,000 self-storage properties being built, accounting for nearly half of the existing properties in the market today. We have witnessed the once sleepy “Mini Storage” business growing in to an institutional and tech savvy industry with large multi-story projects springing up on the corner in every major MSA around the country.
The last decade was a remarkable one for all investors. Stock markets soared and the global economy, though threatened, remained resilient while one incredibly volatile investment stood out from all the rest as the best of the 2010s. Want to guess what it was? Bitcoin. According to a recent report by Bank of America Securities, if you invested $1 in bitcoin at the start of the decade, it would now be worth more than $90,000. As we move into the next decade, investors face a new set of obstacles—from trade wars, to elections, to recession concerns. How will the investment market perform? And more importantly, how will the self-storage industry perform over the next decade?
In 2019, the biggest lesson we learned is that self-storage is not bullet proof. We have seen new deliveries continue to push down rental rates, occupancies and revenue growth. New development continues to be highest in markets with strong employment growth, which leads to outsized population growth and overbuilding. We are stating to see this spill over to the secondary markets but at a very moderate pace.
As we enter the 4th quarter of 2019, self-storage investors are achieving higher than normal returns and extending the valuation push during this unprecedented real estate cycle. Many investors are finding that real opportunity lies in the arbitrage a real estate investor can capitalize on between cap rates and interest rates. While the word arbitrage is usually thought of as high finance concept, there are some viable opportunities that might be available in the self-storage investment market today. The term arbitrage mans that an investor can take advantage of some pricing or other discrepancies in the marketplace. For example, if a stock were selling on the London Exchange for $50 and on the New York Exchange for $55, it would become clear that you should buy in London and sell at the same time in New York. Do it once and you are entitled to call yourself an Arbitrageur (even though it sounds French, don’t let it go to your head). Now that you understand the basic concept, how can we make arbitrage work for us in the self-storage marketplace?
Buying or selling a storage facility is a complex task and one that is not in the frequent course of business for the average self-storage owner or for buyers who are new to the self-storage marketplace. The transaction process can often be confusing, competitive and outright frustrating. However, taking the right approach to prepare for the transaction process can make all the difference in the world. With this in mind, I thought I would take you through some of the most critical parts of a real estate transaction so you can make sure you are competitive in today’s market.
Congratulations, America! We’ve gone longer without a recession than at any time since economists began keeping track of such things. The economy has been expanding for 122 months, beating the previous record of 120 months which was set in the 1990s. However, over the last 30 days we have started to see the rock and roll of changing times; inverted yield curve, market volatility, and to top it off we have an election year looming next year. Economists like to say that expansions do not die of old age. The average U.S. expansion has lasted just 58 months, less than half as long as the current one, but periods of extended growth have been common in many other nations. Australia is enjoying its 28th straight year of growth. Canada, the U.K., Spain and Sweden had expansions that reached 15 years and beyond between the early 1990s and 2008. Without the Sept. 11th terrorist attacks the U.S. might have, too. The current US expansion has seen GDP grow just under 25%, the slowest GDP growth of any modern-day expansion. The economy has grown about 2.3% per year since June 2009 when the great recession ended. That’s almost half the 4.3% average growth rate of the 10 previous economic expansions.
As we close out the first half of 2019, we continue see self-storage asset valuation on the rise. Much to my surprise, self-storage valuations are remaining strong and actually rising in some markets. Although the concept of valuation seems to be quite straight forward, digging a little deeper will give us some insight into the many ways of determining an accurate measure of valuation.
Valuation of self-storage properties is a professional art, and while mechanical number manipulations are a very important part of the process, there is also a large measure of real estate judgment and experience required in developing a precise value range. While we cannot elaborate on every point of the judgment necessary to arrive at a precise valuation, we will try to give you the basics for the number crunching that will help get you in the ball park of valuation but will also make your conversation with your local Argus broker more productive. Argus is now offering a FREE, no obligation opinion of value for any owner that would like us to provide them one.
In my role as Financial Analyst here at Argus, one of the most common themes in my conversations with owners is the softening of rental rates due to the increase in new development that we have seen over the last few years. This increase in supply has forced owners and operators to adjust their rental rates downward in order to maintain occupancy and stay competitive within their property’s submarket. Because of softening rental rates and rising operating expenses, NOI has been tightening; a trend that can be seen industry-wide as the five major REITs have reported NOI growth declines for 11 consecutive quarters.
As a self-storage owner, how do you continue to maintain or raise your NOI in a market that is experiencing headwinds such as declining rental rates and rising operating expenses? As a buyer, how do you find value in a deal where there may not be much short-term upside?
Here at Argus, we spend a lot of time thinking about the value of self-storage properties. It has been our business for more than 25 years; extracting the value of the 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 focused around interest rates, cap rates, new supply, revenue management, embedded value, loan to value ratios and a lot of other topics that rarely interest an owner other than when they decide to buy or sell a property. 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 self-storage property. Now more than ever, the value and preservation of value of self-storage assets is focused around NOI and whether or not the income is maximized and likely to go up or down in the years to come.
One of the most common questions I get as a broker is “where are cap rates today?” This seemingly simple question is more subjective than many people realize, due to considerations including project age, size, market size, property condition, construction type, and trade area demographics. These characteristics are used to classify a storage facility as a Class A, B or C asset.
After talking with several industry experts about cap rates for each asset class at the ISS trade show earlier this month, it became apparent to me that the secondary and tertiary market tea leaves I’m reading are quite different than the ones in the major MSAs.
This year, Argus is honored to celebrate our 25th year in business as the nation’s premier self-storage brokerage. We have seen a lot of changes in the self-storage industry over these 25 years, most notably the tremendous expansion with more than 20,000 self-storage properties built, accounting for nearly half of the existing properties in the market today. We have witnessed the once sleepy “mini storage” business growing in to an institutional and tech savvy industry with large multi-story projects being built on the corner of main and main in every major MSA around the country. Below I have reflected on a few topics that have had the most impact on the storage industry since Argus began in 1994.