As we enter 2023, it is clear that investor sentiment towards self-storage continues to be very bullish. Economists, on the other hand, prognosticate that rising interest rates, inflation and overall economic concerns continue to teeter on recessionary levels. Today stabilized assets are continuing to command very aggressive valuations and undermanaged deals are the golden ticket that everyone is searching for, while lease up and C of O deals are regaining momentum and pricing power. This reinforces that once again self-storage will emerge from a market disruption as the shining star of commercial real estate, largely driven by current self-storage market fundamentals and risk-adjusted rates of return compared to other asset classes along with self-storage’s low capital expenditures.
By Ben Vestal
As we close out 2022 and reflect on the ups and downs of the self-storage investment market, it is now time to turn our sights to 2023. This month, Ben Vestal shares his predictions for the new year and the opportunities that self-storage investors should be on the lookout for.
By Ben Vestal
What a year 2022 has turned out to be! First and foremost, it is our hope that you and your families stay safe and healthy during this upcoming holiday season. This time of year, we find ourselves reflecting on the things that we are most grateful for and the people who mean the most to us. Argus Self-Storage Advisors is made up of more than 50 self-storage professionals around the country who have been helping their friends, colleagues, and clients navigate the self-storage investment market for the last 28 years.
Over the past 12 months we have seen the performance of the self-storage sector accelerate. In the first half of the year values had never been higher, and as we close out the year, we are experiencing rapidly rising interest rates and softening values for the first time in more than a decade. This paradigm shift in the market has all of us reevaluating our business models and investment goals to make sure our investments excel in this changing environment. We are all very thankful that we are in the self-storage industry and below I have outlined a few market observations that set us apart from other commercial real estate and that I am very thankful for.
In these very uncertain times, many owners are giving some thought to selling their property rather than waiting out the market. As we all know, trying to squeeze out every last penny comes with the risk of going on the always bumpy ride of the next real estate cycle. Real estate prices have been gradually increasing over the last several years and self-storage has continued to be the shining star of “niche” real estate sectors. In this time, we have learned that there is a material difference between “thinking about selling” and becoming an actual seller. Eventually, almost everyone will end up being a seller and it is a matter of when that concerns most owners. Thinking through the following factors will help you determine how close you are to actually becoming a real seller which will help maximize your investment returns. Now is a time to be smart, not emotional.
For the last several months the industry has been abuzz about the uncertainty of the real estate markets. By most measures, the self-storage rental business is reasonably steady and as we approach the fourth quarter, I feel it would be appropriate to share with everyone what we are seeing in the market today. As you know Argus has been entrenched in the self-storage industry for more than 28 years, has roots in investment sales and manages one of the largest third-party management portfolios in the industry. This industry reach gives us a unique real time look into the operations and valuation of self-storage properties around the country.
I am writing this letter to give you my absolutely unvarnished thoughts on today’s real estate market and what I believe are an owner’s options in the market today. The options are difficult and limited today because the market is rapidly changing and unusually bifurcated with buyers and sellers viewing the investment world through two totally different sets of lenses. As Q2 2022 ended, I began to think that there was something quite different about this “slow down” as it was beginning to unfold. The self-storage real estate market that had preceded the now accelerating slowdown was and continues to be dramatically resilient compared to other CRE assets and to any previous market. In the first half of 2022, prices were at record highs both nominally and in relation to the incomes of the properties (i.e., extremely low cap rates). This was largely fueled by the large amount of liquidly in the market, strong market fundamentals, and aggressive financing that was available until about the first of June. The market has changed and is now different! Owners must all remember that even though your self-storage business is very resilient, the greater real estate market has more to do with self-storage valuation than the performance of your asset.
It has been a wild ride this summer with economic uncertainty and market sentiment creating a roller coaster for self-storage valuations. However, I am not confident that the run-up in real estate values is over yet. We have seen a 200-250 basis point uptick in interest rates over the last 3 months and shockingly, cap rates seem to still be holding steady. Please forgive my optimism, but I think that self-storage fundamentals are strong, and the increase in value that self-storage owners have enjoyed over the last few years seems to be holding steady as NOI growth seems to be outpacing inflation for the time being. While I would agree that many elements of the economy appear to be unstable, the confidence of self-storage investors seems to be resilient for the time being. Sounds like good news – and it is, for now!
As readers of the Market Monitor have come to know, I think that low interest rates have been the best friend of self-storage owners over the last decade. It now appears that the long downward trend in interest rates has turned and rates are now heading upward. In the late spring and early summer rates for real estate loans, including self-storage, were literally at 50-year lows. Many real estate investors have gone through very long careers and never experienced these historically low interest rates and high valuations. While predicting the future of interest rates is not a high percentage game, I think it is safe to say that in the short to intermediate term it would be reasonable for interest rates to continue to trend up, pushing self-storage values down. Yes, there is a new sheriff in town! It is rising interest rates and inflation. Like many of you, I have been watching the stock market and treasuries closely over the last few weeks and the uncertainty that surrounds the economy and how we are going to curb rapidly rising inflation has never been more pronounced.
After five-plus years of momentum building in the self-storage investment market, buyers, sellers and lenders are proceeding cautiously as the volatility in the overall financial markets has yet to trickle down to our small corner of the real estate industry. In light of the recent market uncertainty, we have asked some of our most active and successful Argus Broker Affiliates to opine on the state of the investment market in their respective markets. Below you will find real time insight on how the self-storage market is performing in each area of the country.
Over the last several weeks, top executives and self-storage owners from around the country have gathered in Orlando at the SSA spring meeting and, just last week, in Las Vegas at the ISS spring tradeshow to discuss industry trends, investor sentiment and overall market conditions. The consensus is that the industry continues to be cautiously optimistic about performance in 2022 and rising interest rates are on the front of everyone’s mind. We saw the ten-year treasury continue to rise last week and peak at over 2.9% with market volatility continuing to gain momentum. Meanwhile, self-storage operating fundamentals seem to be strong and an abundant amount of capital continues to flow into the space.
Over the last 10+ years we have been enjoying a very fluid and robust lending market, fueled by historically low interest rates and high valuations. The latest economic reports are startling as the annual inflation rate in the US accelerated to 7.9% in February of 2022, the highest since January of 1982. Everyone has felt the increase in the everyday costs of housing, gas, and food, just to name a few. Inflation is the scrouge of all savers, diminishing the value of nest eggs and retirement accounts. Among other things, inflation is the result of a “cheap money” policy and the economic stimulus that was implemented during the pandemic. Whatever the cause of inflation, the results can be devastating for most Americans, as it is difficult to find a way to protect oneself against inflation.
Today the self-storage market is white-hot! With billions of dollars of equity looking to be deployed in the self-storage space we are finding that many self-storge owners are receiving unsolicited offers from buyers that are aggressively looking to acquire self-storage assets “off market.” It is not uncommon for a self-storage owner to receive 3-10 phone calls a week from buyers looking to acquire their property and many times these buyers are providing the owner an off market “unsolicited offer,” with little to no property-level information. At first glance, these unsolicited offers seem too good to be true; high valuation, relatively quick closing and no broker commission. The fact is they are too good to be true! The reason that buyers are approaching sellers directly is they want to tie up the self-storage property before fully analyzing the asset or submarket and will ultimately try and buy the self-storage asset at a below market price in an uncompetitive environment. This process is putting many owners in a very bad situation and ultimately costing them millions of dollars.