Self-Storage Fills Up
Investors lock in solid returns with this niche product.
Investor interest in self-storage has skyrocketed during
the last decade. This niche property's stable returns and growing demand are
drawing attention from an array of new investors, particularly large
institutions seeking to diversify their portfolios. These new players are
increasing transaction volume at a record-setting pace: In a recent joint
venture, Extra Space Storage and Prudential Real Estate Investors bought
Storage USA's 458 facilities for $2.3 billion from GE Commercial Finance. This
deal clearly demonstrates that the self-storage asset class has arrived.
Strong market fundamentals further support the
growing presence. The United States has approximately 44,000
facilities totaling 1.5 billion square feet with a market value of
about $120 billion.
Public ownership of self-storage currently hovers around 13 percent,
higher than that of apartment, office, and warehouse sectors. Extra
Storage of Salt Lake City and U-Store-It of Cleveland both completed
public offerings last year, joining existing self-storage real
estate investment trusts Public Storage, Shurgard Storage Centers, and
Self Storage. Other companies quickly are following suit by acquiring
developing properties with the intention of forming new REITs. These
are fueling a consolidation trend that slowly is changing the
self-storage market landscape.
Emerging Industry Trends
Portfolio transactions are gaining more market attention.
Self-storage operators weighing the possibility of a future public offering are
bulking up their total assets to satisfy future public investors, while newly
formed public companies continue to acquire stabilized properties that improve
The Extra Space Storage transaction catapulted the
company to the No. 2 U.S. self-storage operator slot. With 630 facilities
totaling 43 million sf, it trails only industry leader Public Storage. Prior to
going public, Extra Space strategically acquired Storage Spot's portfolio of 26 properties for
$147 million. In addition, prior to its public offering, U-Store-It purchased
National Self-Storage's 3.6 million-square-foot portfolio for $212 million and
entered into a $184 million agreement for Metro Self-Storage's 42-facility portfolio. In the largest
transaction proposed, Shurgard Storage Centers recently rejected an unsolicited
$2.5 billion offer from Public Storage for the entire company. These deals
highlight the market shifts toward consolidation.
However, despite the new public entities and large
institutional players controlling a bigger part of the market, small owners and
operators are still the majority. The largest owner/operator, Public Storage
with 90 million sf and 1,480 facilities, controls only about 6 percent of the
market. Combined, the top 10 companies only control about 16 percent of the
Many small and mid-size operators are aligning with
joint-venture partners using various investment strategies to take advantage of
low interest rates for building and low capitalization rates for selling. For
instance, Morgan Stanley Real Estate's Prime Property Fund recently established
a $400 million joint venture with Safeguard Storage Properties, a private
company in New Orleans with 56 facilities.
In addition, several developers have designated programs
to acquire land or vacant buildings and build self-storage portfolios for
immediate sale. The current liquidity in the market gives these merchant
builders a stable source of potential purchasers. After returns on investment
are paid, merchant builders take the remaining proceeds and reinvest in new
development deals for future sale.
Another recent trend centers on builders that are selling
non-stabilized properties with repositioning potential. Even some newly
constructed facilities are attracting buyer interest prior to leasing. For
example, Devon Self-Storage in Emeryville, Calif., has developed a systematic
program to acquire and convert obsolete warehouses and recycled big-box stores
into state-of-the-art self-storage facilities. Devon regularly partners with
pension funds to develop and aggressively lease up the facilities. When the
properties are near stabilized occupancies they are packaged together for sale.
Though the landscape continues to evolve, there are two
distinctly different types of self-storage investors - institutional and
private. Most institutional investors, such as opportunity funds, pension
funds, and life insurance companies, require shorter investment terms and will
consider higher risk projects with correspondingly higher yields than most
In addition, institutional investors typically are not
interested in long-term joint ventures. Their objectives are to invest capital
into a development and obtain a return on investment upon selling. Most
institutional investors prefer three- to five-year terms, although recently
some are considering individual fund terms of five to seven years.
Since some institutional investors are investing from
commingled funds that have expiration dates, they must invest in shorter-term
intervals. For example, an institution may require that it receives its initial
investment back plus a minimum internal rate of return of 20 percent within
three to five years. Most institutions also look at development opportunities
because they more likely will generate their minimum IRR, often in the high
teens to low 20 percent range.
In contrast, most private investors are high-net-worth
individuals or private funds that frequently want to own properties long term,
often for an indefinite time period. A private investor may be less likely to
look at an IRR calculation to determine its interest in a specific self-storage
development. Less interested in a rapid payback, most private investors seek
returns on total cost in the range of 11 percent to 14 percent. Private
investors often evaluate investment opportunities by calculating the project's
IRR based on a fictitious sale in five years. The real test for many long-term
private investors is to analyze the percentage of their original equity
investment that will be returned upon a refinancing in two to four years.
In recent years, the capital markets have expressed
confidence in self-storage through the diversity of financing options
available. Owners seeking to purchase self-storage facilities may choose
between fixed- and floating-rate loans; construction and bridge financing are
readily available from local banks, credit companies, life insurance companies,
and investment banks.
The proliferation of commercial mortgage-backed
securities makes five- to 10-year loans a desirable financing option. These
securitized loans typically feature low interest rates and high loan-to-value
financing of 75 percent to 80 percent without a requirement for personal
Abundant long-term financing is evident as current CMBS
transaction volume is projected to exceed last year's $1.2 billion.
Additionally, CMBS self-storage loans funded over the past 10 years have the
lowest default rate of all property types at less than 1 percent, which
compares favorably to the 4.5 percent average delinquency rate for all other
property types. Standard & Poor's rating of $4 billion of CMBS loans
secured by self-storage shows only five out of 1,102 loans are delinquent, with
a .24 percent delinquency rate.
Risks to Consider
While the self-storage segment continues to prosper,
capital can retreat from the market as swiftly as it entered. Self-storage risk
characteristics are most similar to the multifamily sector. However,
self-storage maintains a 150 to 200 basis point spread over apartment
transactions. While capitalization rates for the entire self-storage sector
averaged 8.5 percent to 9.0 percent last year, institutional-quality assets
currently trade in the 6.75 percent to 7.5 percent range.
Negative news such as flat or falling rental rates or
even defaults regarding one or more high-profile operators could affect
investor sentiment toward the entire sector. A steady rise in interest rates
likely will slow activity in highly leveraged transactions, as the spread
narrows between current cash yields from self-storage properties and the cost
of financing. Even a gradual improvement in rents would only partially offset
higher interest rates.
Competition from new self-storage developments also
limits investors' interest in purchasing existing facilities. Income generated
from properties no longer directly relates to market values. Many markets
previously believed to possess strong barriers to entry have lost this
advantage. New facilities are getting approved in previously high-barrier
markets with strict zoning regulations due, in large part, to the emerging
sophistication in the aesthetics of new self-storage facilities.
The U.S. self-storage market has matured over the decade
with more-professional facilities, greater industrywide information, and
more-sophisticatedmarketanalyses. These factors and many others have contributed to a new wave of
institutional investor interest in the sector. Yet despite the industry's
recent growth spurt, small owners and operators still dominate the market,
making it a highly fragmented but intriguing option for many investors.