Stock Up for Lean Times
The self-storage industry is benefiting from continued economic growth, but storm clouds could be on the horizon.
Congratulations, America! In October, the economy entered its 123rd consecutive month of growth, beating the previous record of 120 months set in March 2001. This is the longest the country has gone without a recession since economists began tracking such things.
This growth has been slow but steady. Gross domestic product increased by nearly 25 percent during the current U.S. expansion, the slowest growth of any modern expansion, and the economy has grown about 2.3 percent per year since June 2009, when the Great Recession ended. That's more than half the 4.3 percent average growth rate of the 10 previous economic expansions. And now, concerning economic factors have made the news of late - inverted yield curve, market volatility, and, to top it off, an approaching election year.
Looking at the economic downturns over past 25 years in the self-storage business - especially the Great Recession - many self-storage owners and investors were caught off guard by the timing and severity of these events. Although self-storage fared better than other real estate sectors, owners experienced occupancy declines and mortgage defaults. Many also had difficulty maintaining net operating income and cash flow.
While it is difficult to predict when a recession will occur, there doesn't seem to be a major one on the horizon. However, a small, stealthy recession could be coming soon, and it's prudent for those in self-storage to prepare now. The tricky thing about recessions is that we will already be in one by the time economic data from the previous two quarters are released to provide confirmation. We will most likely slip into a downturn without even knowing it.
From 2013 to 2018, the self-storage development wave was in full swing around the country; that growth is expected to taper off through 2020. Due to product awareness, developer confidence, low interest rates, and fluid debt and equity markets, an abundance of new self-storage projects have been built in every major market.
With low short-term interest rates and a dip in long-term rates, the current market condition continues to push strong valuations and further compress cap rates. The Fed announced a decrease in short-term interest rates by 25 basis points in July. While this may be a preemptive measure to cushion the economy from a global slowdown and uncertainties around trade, this action by the Fed should be a warning sign that the economy is not growing as fast as it once was. It's time to proceed with caution.
How can you prepare for the next economic slowdown? The greatest risks to self-storage are overbuilding, rising interest rates, and lacking new financing to take down maturing construction loans or refinance maturing debt. Here are five suggestions to help self-storage owners prepare:
The greatest risks to self-storage are overbuilding, rising interest rates, and lacking new financing to take down maturing construction loans or refinance maturing debt.
- Lock in long-term debt. With some of the lowest interest rates in recent history, be sure you have enough term on your debt to endure several years of a stalled economy and debt market. Do not over finance, and keep the loan-to-value in line so you can endure lower rental rates and fewer occupancies in the event of a slowdown.
- Utilize professional management practices and keep current with new management tools, such as the ability to rent online, remote management, dynamic pricing, and revenue management.
- Maintain your property. If there are any major maintenance projects that need to be completed, don't delay. It is better to replace a roof now than when under the stress of more competition, lower rental rates, and other recession-related challenges.
- Maintain substantial cash reserves. Being able to act quickly when new acquisition opportunities present themselves will help ensure value creation and a more diversified real estate portfolio.
- With the 2020 presidential election looming, any real change in the economy over the next six or nine months is unlikely. However, be able to anticipate changes in fiscal policy that could affect the economy in general. In particular, focus on the availability and cost of capital. Stay informed about the economy and how to remain competitive in your self-storage business.
Although the U.S. economy is still growing, albeit rather slowly, other countries could pull us into a global recession. Watch for signals like defaults on consumer debt, such as car loans, credit cards and student loans, that often precede more serious slowdowns. The time to prepare is now - the U.S. economy by most measures is healthy and doing well, but that can change in a few quarters. When this will happen, we don't know, but we can watch for signals and be well-prepared to weather the storm.