After 10+ weeks of quarantine we are starting to settle into the new reality of navigating the investment market in light of the COVID disruption, and it is clear that this is going to take a while to work its way through the system. Like many of you, I have been watching the volatility in the stock market closely in recent weeks as uncertainty surrounds the investment market. Additionally, Argus has been collecting data points with regards to operating metrics, self-storage investment pricing and self-storage market sentiment. On May 13, 2020 we held a webinar with some of the most active and well-respected self-storage professionals in the industry. We held off on hosting a webinar until we could provide real market data points to share with the group and offer real guidance to our clients in these volatile times. Below I have summarized the key takeaways from the session, and if you would like to watch a recording of the entire Q&A please click here. If you have any questions or would like to follow up with any of the panelists, please reach out to your local Argus Broker.
Like many of you, I have been watching the volatility in the stock market closely in recent weeks as uncertainty surrounds the COVID disruption, the new CARES Act and how effective it will be. I’m still not sure if it is a good idea or a bad idea, but I am concerned about the overall market and the fact that real estate loans are getting tougher to find. After twenty-plus years in the real estate business I thought I had seen everything that a market could throw at us, but this time it has thrown everything at once!
The economic environment of the last several weeks has been devastating not only to the stock market but also to the commercial real estate market. Few self-storage owners realize the full extent of the devastation this market disruption has had on self-storage projects because unlike the stock market, there are no daily quotes to tell you what is happening in the self-storage world. While I can’t tell you exactly how much your property value has declined, I can tell you that the average property value is down between 0%-25%, simply based on the change in market sentiment and investor confidence. If your revenues are down as well, the value will also be down by roughly the same percentage as the revenues in addition to the above declines.
WOW! There’s never a dull moment in this world. First and foremost, it is our hope that you and your families are staying safe and healthy during this unprecedented time. Due to the coronavirus we suddenly find ourselves in a situation that we have never dealt with before and there are many questions for which we have minimal answers at this time. The acceleration of overall anxiety in the past two weeks related to the coronavirus has made most recent economic reports irrelevant. The financial shock that markets are experiencing is likely to weigh heavily on economic growth prospects for at least the next few quarters. The one thing that I DO KNOW is that we will get through it.
Because of our common interest in the self-storage industry, I want to share with you some takeaways, resources and thoughts from the last few weeks’ activity. Argus is the only full-service self-storage advisory firm that includes third party management, investment sales and advisory services, so we have a unique perspective that is all-encompassing for self-storage owners. Below we have tried to touch on some key points regarding the investment markets and also provide some tips for self-storage owners and operators. If you have questions about how we are handling any part of our business during these unprecedented times, please don’t hesitate to reach out and we will provide you with guidance and resources.
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?