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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   February 2011

Find Big Business in Self-Storage

Get to know why this asset class performs better than others — and how you and your clients can benefit

Find Big Business in Self-Storage

Commercial mortgage brokers in search of more-glamorous types of real estate often overlook originating loans for self-storage as an investment property. This asset offers unrivaled opportunities for exceptional total return and for sustainable, positive cash flow with low loan losses, however.

Brokers who understand the fundamental value of this growing industry — along with its seasonal and economic cycles — can provide their clients a competitive edge in the acquisition, building or expansion of self-storage facilities. They may need to educate their clients about this property type’s attractive traits. Self-storage, in fact, performs as well as or better than the traditional members of the core asset classes, which include office, industrial, retail and multifamily.

The self-storage industry has been the fastest-growing sector of commercial real estate in the U.S. in the past 30 years. According to the nonprofit Self Storage Association, it took more than 25 years for the self-storage industry to build its first billion square feet of space; the second billion square feet was built in just eight years — from 1998 to 2005. Even in the past few years’ economic recession and capital crunch, self-storage market conditions have remained fundamentally stable — suggesting it is largely recession-resistant.

Today, debt and equity capital is returning to the self-storage asset class, causing an increase in sales volume, a return to portfolio sales, and a decrease in overall capitalization and yield rates. The sector’s resilience isn’t the only reason brokers and their clients should consider this property type a core real estate investment. 

• • •

According to the National Council of Real Estate Investment Fiduciaries, the expectations of a core asset are:

  • Stability;
  • Consistent cash flow;
  • Potential for capital appreciation;
  • Hedge against inflation;
  • Solid returns (well above bonds); and
  • Modest risk (well below stocks).

The self-storage asset class meets these  expectations. Here’s how.

Stability and cash flow

Self-storage market conditions historically have been fundamentally stable. The national trend data show some remarkable results that explain the rise of this asset class

In the 14-year time frame shown in the graph below, total supply more than doubled from 3.31 square feet of self-storage space per person in 1995 to 7.03 square feet of self-storage space per person in 2009 — a compound growth rate of 5.53 percent per year

Even while supply doubled, national occupancy ranged from 82.9 percent to 89.4 percent with an average of 86.72 percent. Moreover, the average monthly rental rate for a 10-by-10 storage unit went from $56.02 in 1995 to $83.54 in 2009, a compound rate of growth of 2.9 percent

The supply of self-storage space more than doubled, but vacancy remained relatively stable and rents increased, suggesting that this is an asset class that is resistant to recession. To test resiliency, a simple scoring model is analyzed that sums rent and occupancy to get a score for each year. The data indicate that in the 2001 recession year, the score declined 3.35 percent to 138.8 from a score of 143.61 in 2000. The next year, the score increased 6.76 percent to 148.18

Net operating income increased at a compound annual rate of 2.02 percent from 2001 to ’08, according to a recent industry survey — another indication of stability and good cash flow in this asset class.

Appreciation and inflation 

One of the best measures of potential for appreciation is found in overall capitalization rates. Self-storage cap rates between 2003 and ’10 remained relatively stable, but they show a general decline from 9.52 percent in ’03 to 8.45 percent this past second quarter. Current declines are a function of capital returning to self-storage and relatively low interest rates.

In terms of returns on equity, self-storage has remained relatively stable near 8 percent. As to inflation, a more complex analysis indicates total equity yield greater than 15 percent for self-storage with similar debt costs

Generally, assets with shorter lease terms tend to provide the best inflation hedge because owners typically can adjust rents as needed. Rents are more easily marked to market than other asset classes because demand for self-storage is a function of the local trade area, typically within a three-mile radius. And because rents are fee-simple and not leased, the owner can increase them at any time to reflect the impact of inflation. Self-storage revenue-enhancement programs are successful at increasing rent — in fact, the rent for existing tenants often is greater than the quoted street rate to new tenants and does not significantly impact vacancy rates.

Solid returns

Based upon a statistical analysis of information from the National Association of Real Estate Investment Trusts (NAREIT) about annual average returns by property sector, self-storage has outperformed the office, retail, industrial and apartment sectors in the five-year, 10-year and 15-year periods between 1994 and 2009

In fact, average returns for self-storage were in the double digits for all three time periods. From 2005 to ’09, the self-storage sector saw an average return of 11.22 percent, according to NAREIT data. The highest returns from the core properties were from apartments, with an average annual return of 6.89 percent

In addition, self-storage offered a lower standard deviation across all property types in the five- and 10-year periods. This is yet another reason brokers and property-investors should embrace self-storage as a core real estate asset class.

Modest risk

Even in the economic downturn, the self-storage market’s loan-loss conditions have been the lowest of any asset measured. In an industry analysis of securitized debt, self-storage showed a calculated loss rate of 0.2 percent compared to an average of 1.53 percent across multiple property types. To compare, multifamily losses were calculated at 1.51 percent; health care at 8.17 percent; hotels at 3.92 percent; industrial at 1.52 percent; office at 1.23 percent; and retail at  1.08 percent.

In addition, self-storage had the lowest calculated default rate at 4.68 percent. The core properties had significantly higher default rates, ranging from 10.44 percent for office properties to 14.53 percent for multifamily housing.

• • •

A relatively new industry in terms of investment, self-storage has come into its own. Commercial mortgage brokers should advise their clients of the sector’s steady cash flows, low break-even point, minimal capital expenditures, and lack of tenant improvements or leasing commissions. These features make it clear why self-storage could be the core asset for which your property-investor clients  are looking.


 


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