Self-Storage Steps Up
Investors find big returns in this unassuming asset.
Despite the difficult economy and market challenges
during the past four years, self-storage as an asset class has continued to
provide solid performance and stable returns for investors. Once dominated by
mom and pops, or small, independent owner/operators, the self-storage industry
has evolved into a top-performing asset class during the past decade.
An Evolving Industry
Though once barely on the radars of major investors,
self-storage has taken off among institutional-level investors in recent years.
Since 2010, real estate investment trusts have demonstrated an almost
insatiable appetite for properties larger than 45,000 net rentable square feet
in the top 25 metropolitan statistical areas. In 2011, self-storage REITs
boasted a handsome return of 35.4 percent — the strongest of any REIT — for the
second consecutive year, according to the National Association of Real Estate
Despite the changes in the self-storage industry,
approximately 83 percent of these properties nationwide remain in the hands of
small, independent investors, according to the 2012 Self-Storage Almanac. Most sellers today are not disposing of their assets to
capitalize on the improving market. Rather, sellers are often driven by life
events that motivate them to sell at a reasonable price.
With affordable capital available through debt and equity
providers, small investors are starting to take advantage of self-storage investment opportunities in secondary markets. The nearly historical high
spreads between capitalization rates and interest rates in secondary markets
have allowed small investors to generate very compelling cash-on-cash returns.
How Does Self-Storage Stack Up?
Self-storage has managed to maintain stable occupancies
throughout the economic downturn. At year-end 2012, only 4 percent of
self-storage commercial mortgage-backed securities loans were in delinquent
status — the lowest delinquency rate among all major commercial real estate
asset classes, according to Trepp data. With cap rates hovering around 7
percent nationwide, self-storage is in line with other core real estate asset
classes, according to the PwC Real
Estate Investor Survey, 2Q 2012.
However, the growing institutional buyer focus on
properties in the top 25 MSAs has led to overall cap rate compression in these
markets. The cost of capital for institutional buyers ranges from 100 to 300
basis points less than the cap rate yield, thus providing a positive return on
equity for a leveraged transaction. The availability of capital through CMBS,
banks, and life insurance companies provides good debt options with very
Armed with enormous amounts of equity, large buyers
generally concentrate on properties in excess of 45,000 sf as well as portfolio
transactions. These larger facilities and portfolios have also enjoyed strong
upticks in rental rates around the country, particularly in the top markets. In
2012, there were 29 self-storage portfolio transactions, creating opportunities
for big investors to purchase large amounts of core self-storage assets. Cap
rates for the larger deals in major MSAs range between 6 percent and 7.5
Cap rates for smaller properties and properties in
secondary markets range between 8 percent and 10 percent. There are numerous
financing options available for smaller properties, including banks, CMBS, and
life companies that are willing to lend in the $1 million to $5 million range.
Current interest rates for these loans are in the 3.5 percent to 5 percent
range, giving small buyers the opportunity to realize an arbitrage of a 300- to
500-basis point spread between interest rates and cap rates. This has created
very compelling cash-on-cash return for buyers today. These persisting low
interest rates are a driving force behind compressed cap rates and are
providing high returns to self-
storage investors overall.
During the past five years, very few self-storage projects
have been developed across the country, which has allowed existing properties
to enjoy the benefits of an improving economy and higher occupancies. As the
economy continues to improve, new development is picking up in markets where
fundamentals are strong. Further fueling this trend is banks’ willingness to
consider more reasonable construction financing terms. Markets such as Denver
and Dallas are leading the way with strong rental rates accompanied by high
occupancies and are enticing self-storage developers to move forward with new
projects or expand existing properties. Denver currently has 16 self-storage
projects on the drawing board consisting of more than 1 million sf, all of
which is scheduled to come on line in the next 12 to 18 months. The combination
of strong returns and low default rates attracts investors to the opportunity
that self-storage affords.
Drivers of Success
As Wall Street and the investment community have taken
notice of self-storage as a viable commercial asset class, the underlying
dynamics continue to fuel the sector’s success. Key drivers of this performance
include the fact that self-storage has no need for tenant improvements or
leasing commissions, which results in higher net rental income than most
commercial real estate alternatives. The additional low maintenance
requirements also contribute to increased bottom line performance.
The generally large tenant base and short-term nature of
self-storage leases allow owners to react quickly to changing market conditions
and also protect owners from long-term vacancies that occur in other commercial
real estate assets. In addition, self-storage has a higher 10-year average
return than any of the major property sectors. Because of these operating
characteristics and the flexibility short-term leases provide the operators,
self-storage continues to be underestimated by many investors.
With solid past performance and upward trending
occupancies and rental rates, self-storage has captured the attention of large
institutional investors as well as regional and small investors. The rising
star of commercial real estate industry may not shine forever, but it appears
it to be on a favorable course for the foreseeable future.
C. William Barnhill, CCIM, is president of Omega Properties in Mobile, Ala. Contact
him at firstname.lastname@example.org. Ben Vestal is president of the Argus Self-storage Sales Network, a
nationwide affiliation of commercial real estate brokers who specialize in
self-storage transactions. Contact him at email@example.com.