Mini-Storage Grows Up

New Upscale Developments Acquire a Sophisticated Look in City and Suburban Locations.

In the past two decades, the U.S. self-storage, or mini-storage, market has grown from its Texas-born infancy into a $5.5 billion industry. From fewer than 1,000 facilities nationwide in the mid-1970s to more than 25,000 today, the approximately one billion-square-foot industry currently boasts a national average occupancy rate of an estimated 90 percent.

Low operating and building costs, limited landlord/tenant liability, and high returns have attracted developers around the country. In addition, new self-storage projects often begin generating revenue even before completion, and they have minimal traffic and environmental impact.

But this fast-growing industry continues to evolve in location, design, and amenities. Once, long rows of one-story buildings with 40,000 square feet (sf) to 60,000 sf of rental space sat on 2.5 to five acres of rural land. Today, more sophisticated self-storage developments inhabit higher-traffic commercial areas in top metropolitan markets.

Increasingly, successful developments require more expensive land in highly visible locations. Facilities with the high level of finish and amenities necessary to justify high rental rates require prime commercial land. For example, Public Storage, Inc., recently paid $1 million for a 1.3-acre site on upscale Roswell Road in Atlanta, where it constructed a 46,000-sf facility on the site at a cost of $4 million.

Capital Markets
As professionalism and experience drive new self-storage developments, the best operators of the 1980s have sought to expand through acquisitions. Industry leaders have developed sources of funding beyond traditional bank financing and limited partnerships. Companies such as GE Capital, Heller Financial, and major pension funds are financing self-storage development and acquisition through substantial lines of credit. They also fund mortgages offered through national self-storage mortgage specialists.

Firms such as Finova Capital, First Security Commercial Mortgage, and Self Storage Mortgage Corporation have focused on self-storage financing. In many cases, they’ve taken permanent financing out of the banking community.

The greatest financial influence has been the emergence of self-storage real estate investment trusts (REITs). REITs’ access to low-cost capital has helped fuel the growth explosion. The first, Public Storage, Inc., is the largest self-storage REIT, with close to $2 billion in equity. In 1994, Shurgard Storage Centers, Storage USA, Inc., and Storage Trust Realty each launched REIT initial public offerings. Sovran Self Storage followed in 1995. As many as three additional operators may go public as REITs within the next two years.

With a market share of about 7 percent, Public Storage remains the largest self-storage operator, with 67 million sf of rental space in almost 1,200 facilities, according to Mini-Storage Messenger, an industry publication. Storage USA, Inc., is the second largest operator, with about 22 million sf. In rankings based upon the total number of facilities, U-Haul International is second largest, with 810 properties.

However, the top 10 operators control about 16 percent of the entire market. Despite the influx of REITs, individual entrepreneurial operators still dominate the self-storage market. Independent owners, with an average of two facilities each, control about 84 percent of the total facilities nationwide.

With such a small percentage of market share controlled by large players, the industry is primed for consolidation. Regional and national operators are looking to increase their market share, especially in top metropolitan markets.

The influence of the capital markets, coupled with the increased need for professional expertise and the trend toward more expensive sites and facilities, will accelerate the consolidation trend. By the end of the decade, the industry’s top 10 self-storage firms are likely to control more than one-third of the space.

Sellers’ Market
The readily available resale market created by REITs and other large operators has encouraged new development. Developers who build investment-grade facilities of 40,000 sf or larger in major market areas can be assured of the option of selling.

Although REITs look to acquire investment-grade facilities at or above 10 percent capitalization rates, they have been settling for 9 percent or even 8 percent for high-quality facilities in prime commercial areas. Recent transactions have surpassed $90 psf for the best-located facilities, according to Inside Self Storage, another industry publication.

Even in today’s strong market, many owners are reluctant to sell their facilities because of capital gains tax that may add up to 40 percent of the gain in a property’s value. A popular alternative for owners seeking to defer capital gains is to exchange their properties with a REIT using an umbrella partnership real estate investment trust (UPREIT) transaction.

An UPREIT allows the owner to defer tax on the sale—instead of paying cash, a REIT pays an owner in partnership units that have income distributions equal to dividends. (See "UPREITs and DownREITs Gain Popularity," CIREJ, March/ April 1998.) Taxes only are paid when the owner elects to convert the partnership units into common stock of the REIT or into cash. Through an UPREIT, an owner can maximize the price of the facility and share the diversity and expertise of a REIT, while enjoying liquidity and potential stock appreciation.

New Trends
The evolving nature of self-storage has prompted several trends in new facilities and the industry itself.

Upscale Exteriors. Attractive structures resembling retail and office properties are replacing traditional facilities that have metal doors and chain-link fences. Such high-end exteriors help to attract upscale renters and, subsequently, premium rental rates.

In Northfield and Lake Forest, Illinois, two affluent suburbs of Chicago, Northfield-based Lock Up Development Corporation recently constructed multilevel facilities that resemble glass and stucco office buildings complete with carpeting and air-conditioning in all units. While nearby competition charges $126 a month for a 10-by-10-foot storage unit, the new Lock Up facilities charge $215 a month for climate-controlled units of the same size.

This upscale approach allows facilities to stand out in an increasingly competitive business and helps win zoning approvals in residential neighborhoods. Other facilities, such as Chicago-based Strongbox Self Storage and East Bank Storage even have temperature- and humidity-controlled wine cellars for individual collectors and local restaurants.

Climate Control. The increasing demand for climate-controlled space, whether it is air-conditioned or heated, is one of the most significant trends in the industry today. Nationally, 13 percent of self-storage facilities have at least some climate-controlled units. This number likely will continue to climb as more facilities are built. The demand for heated, cooled, and/or humidity-controlled storage space is strong enough to provide higher returns than conventional storage.

Climate-controlled facilities generally are located in high disposable-income areas where residents need to store temperature-sensitive items such as art, electronics, and wood furniture. Many developers are planning new facilities with vents and ducts that easily can be converted to 100 percent climate-controlled.

The average climate-controlled unit rents at about a one-third premium, but in certain markets, owners receive two and three times their regular rental rates.

Adaptive Reuse. One of the few bargain opportunities still available to potential self-storage owners is converting obsolete retail and industrial space into new self-storage facilities.

Candidates for conversion frequently are well located, with existing heating, ventilation, and air conditioning systems. For instance, the Devon Group of Emeryville, California, has converted 16 retail buildings nationwide and a Coca-Cola plant into self-storage facilities, a strategy that delivers climate-controlled space for substantially less than the cost of building comparable new space.

Self-storage has salvaged a number of commercial building types. Storage Trust successfully converted an 11-story hotel in New Orleans, acquiring the hotel for less than the cost of its land and converting it at considerable expense—justified by the bargain price. The company removed all sinks and toilets and boarded over bathtubs to create large shelves. The former bathrooms are now small units rented to nearby college students.

One of the most unique storage conversions is located underground. Hall’s Self Storage is in a densely populated area of Chicago adjacent to a Menards home improvement store. The basement of the store was deemed undesirable retail space, but proved to be ideal storage space. The property owner, an avid exotic car collector, believed the 80,000-sf basement could be converted into automobile storage because the neighborhood had few homes with attached garages. The basement was equipped with a concrete ramp from the street level and quickly filled up with cars.

Franchising. One industry trend that bears watching is the popular retail concept of franchising. Storage USA is targeting developers with franchise opportunities. Franchises are offered operations and marketing expertise, as well as design and building services. Qualified franchisees also are offered access to construction financing that new developers may not otherwise obtain.

Marketing. Marketing in the self-storage industry is growing in importance to the competitive owner. Typically, the best advertising source for this industry is the telephone book’s yellow pages. Other promotional tools include: attractive, high-visibility signage on and off site; advertising in discount leaflets, radio or television; and special occasion or grand-opening promotions.

In addition, the most astute self-storage operators are looking beyond space rentals to draw customers, implementing additional revenue-boosting services. They can integrate numerous ancillary products and services into self-storage operations with minimal investment, space, and staff. These include mailbox rental; shipping, notary public, fax, and copy services; and sales of postage stamps, carton and packing materials, signs, and banners.

Forecasting Demand
Although the demand for self-storage units continues to expand, in certain areas supply may be outstripping demand. As would be expected, the increase in competition has had a negative impact on national rental rates, which saw a 3 percent decrease in 1997, the second annual decrease in a row, according to the Self-Storage Almanac.

However, not all unit sizes showed decreases. Smaller units showed increases in all regions except the south central.

West. The country’s western region has experienced rate decreases in all unit sizes except five-by-five units, which increased about 3 percent.

South Central. The south central region still has the lowest rates in the country and remains steady regardless of the trends in other regions.

North Central. With the second-lowest rates in the nation, the north central region traditionally has been a strong performer. Last year, average rate increases were less than 1 percent.

Southeast. This region experienced increased rates for all sizes—the only region to do so.

Northeast. The northeast has the highest rental rates, and that trend continues. As a whole, the rate decrease last year was fairly low at 0.5 percent.

Self-Storage Supply
How much supply can a given market accommodate? A number of factors may be analyzed to form an estimate at the local level.

The old standard of forecasting an adequate supply was to estimate the number of sf per person in the market. If the local supply was less than about two sf per person, the area generally was regarded as being able to support an additional facility. But this standard no longer is considered an accurate measure. As commercial tenants continue to increase their approximately one-third share of the customer mix, the average supply of self-storage space now is considered to be between two to four sf or more.

As competition intensifies, self-storage owners must continue to differentiate their product through new innovations in design, technology, and marketing.

Marc A. Boorstein, CCIM

Marc A. Boorstein, CCIM, is a principal with MJ Partners Real Estate Services in Chicago, a full-service real estate brokerage company specializing in the evaluation and sale of self-storage facilities located nationwide. Contact him at (312) 726-5800 or Two Faces of Self-Storage LendingToday’s lenders are of two minds about the self-storage market. Some prefer to focus on more established commercial properties, because they view self-storage facilities as high-risk operations. They balk, for example, at the management-intensive nature of the business, citing high turnover rates and collection dynamics reminiscent of the hotel industry. According to the 1997-1998 Self-Storage Almanac, the average rental period for residential self-storage facilities customers (who represent 76 percent of business volume) is just 10 months, and 21.3 months for commercial customers. The same source lists the 1997 average occupancy rate at 85.1 percent. Lenders with experience in this market, however, see a different picture. Heller Financial, for example, focuses on facilities with proven track records, experienced management, and higher local profiles, because these properties boast occupancy rates closer to 90 percent. Experienced lenders also note that the average cap rate of 10.6 percent, based on data compiled by the 1997-1998 Self-Storage Almanac for 172 selected facilities nationwide, declined from the 10.7 percent reported a year earlier.Still, shifting market conditions can present significant challenges for lenders. The abundance of capital available to developers today creates a very real danger of overbuilding, especially given the relative simplicity and low cost of constructing self-storage facilities. With developers rushing ahead with new projects and REITs beginning to consider new development as good acquisition opportunities dry up, lenders must monitor local market conditions carefully and exercise restraint when supply begins to outpace demand.Today’s self-storage industry has much to offer owner/operators, brokers, and lenders. Market and demographic forces are creating new pockets of opportunity in areas such as Arizona, Florida, California, and New York. The industry also is strengthening its appeal by introducing new products that respond to evolving consumer demand. The prospect of increased consolidation promises to drive self-storage valuations higher, as well as raise the industry standard for operating efficiency and marketing sophistication. As long as developers, brokers, and lenders exercise discipline, the industry should be able to sustain its current rate of profitable growth.— by Richard Cline, a vice president and product manager for the manufactured home and self-storage markets at Heller Real Estate Finance in Chicago. Contact him at (312) 441-6771.