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.
Argus is celebrating it 25th year in business this year, and in that time we have learned a great deal about what makes a successful transaction. An important part of that process is explaining what a real estate broker does and why we get paid to assist our clients in buying and selling self-storage properties. The value of professional advice during a self-storage transaction cannot be measured by wins and losses. In fact, often the most valuable advice does not even lead to a transaction. With the recent popularity of self-storage assets, we have seen many new non-storage brokers entering the space and offering their services to owners. It is important to understand that experience does matter and aligning yourself with a well-established self-storage broker will provide you with the best opportunity to maximize your investment.
Over the last several weeks, top executives from around the self-storage industry have gathered in New York City and Aspen to discuss industry trends, investor sentiment and the overall market outlook for 2019. The consensus was that industry executives remain cautiously optimistic about self-storage performance in 2019, in light of the interesting changes that we saw in the last few months of 2018. Much to my surprise, we saw the ten-year treasury decline to the mid 2.5%-2.8% range, self-storage development seems to be slowing or a least cooling off and we clearly have an abundance of capital still looking to invest in the space.
Meanwhile, the phone 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, estate valuation or selling. Argus is now offering a FREE 2018 sales comp report for each of your markets. Argus has tracked and inventoried more than 1,000 self-storage sales comps for 2018 and we were involved in more than 100 transactions nationwide in 2018, which puts us in a unique position to advise our clients. If you would like to receive this free report, please contact your local Argus broker.
The holidays are upon us and cautious optimism is certainly present in today’s self-storage investment market. Recent market volatility has pushed the Ten-Year Treasury back down below 3% and lenders, buyers, and owners are still bullish on self-storage assets. This, along with recent operating performance has breathed new life in to the already historically long self-storage run.
After exhibiting an incredible pace of growth over the last several years, the self-storage industry is showing signs of slowing to a more sustainable pace in 2019. Cap rates and values in most markets are expected to be flat and not compressing further, however we are also not anticipating any rise in cap rates as there is still meaningful demand and bidding competition from qualified investors. This late cycle expansion has continued to allow late movers to capitalize on a very fluid transaction and financing market. However, some sellers that hold out for the final dollar will be left wondering what happened when the investment market officially turns downward. Remember, it is better to be a year too early than a day too late!
In 2018, the biggest lesson we have learned is that not all markets and self-storage operators are created equal. We have seen new deliveries continue to push down rental rates on a national level, but revenue growth remains positive. New development continues to be highest in markets with strong employment growth which leads to outsized population growth. As I have traveled the country attending self-storage meetings and touring self-storage projects, I have noticed some common themes; overall everyone is happy, they have good jobs, the economy is growing, self-storage is still a desired asset class and for now life is good. Below I have noted four key positives and negatives that we have learned about the current self-storage market:
Much like the Colorado Rockies’ baseball season, which lasted longer than anyone thought, the era of record-low, long-term interest rates appears to be over with Prime, LIBOR and Treasury Rates at levels not seen in quite a few years. But where are rates headed from here? Is there enough factual evidence to warrant four more increases to the Fed Funds rate as currently anticipated? Let’s take a look at how we got here and all of the factors currently at play.
In 2008 when it was clear that we were in a recession, then Federal Reserve Chairman Ben Bernanke lowered the target Fed Funds Rate to 0% in an effort to stimulate the economy by encouraging borrowing by both consumers and businesses.
The economic environment of the last several years has been very favorable for self-storage values and operating performance. In fact, we have enjoyed the longest economic boom the self-storage industry has ever experienced. This has been spurred by strong operating performance, improving market fundamentals, better industry data, fluid debt markets, quality third party management platforms and a growing customer base. In short, when evaluating risk-adjusted returns and comparing self-storage with other commercial real estate investments, the returns are higher, and the various risks are more moderate, except for the risk of overbuilding.
We are just now starting to see some operating softness in select markets that over the last 12-28 months, have experienced a large number of new projects coming on line. This has led some buyers to shy away from these particular markets. Most of the new development has taken place in the top 25-50 MSAs and is largely concentrated in specific areas within these markets.