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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   July 2018

The Self-Storage Niche Is a Deal Generator

Opportunities abound for pursuing these relatively low-risk transactions

E-commerce giant Amazon is a major character driving the national real estate story these days, and the self-storage sector is a major subplot in that narrative. No matter where you go in Seattle — the company’s headquarters city — and the surrounding area, you will see self-storage facilities popping up alongside new apartment buildings and offices. c_2018-07_meyer_spot.jpg

The same pattern is evident around the country, as people move for new jobs or other life events, often putting goods in storage. Sleek new self-storage buildings, many of them multistory, have been built in large numbers in urban neighborhoods during the past five years, catering to millennials and older tenants alike. 

That translates into demand for financing. Fortunately, there’s a deep capital pool out there, ranging from local banks and credit unions to Wall Street conduits and life insurance companies. Yet, the highly localized nature of the self-storage market, and the predominance of smaller operators, means that borrowers’ financing needs are extremely varied and don’t always meet the conventional criteria. Private lenders can help fill that gap with short-term bridge loans for acquisitions, refinancing or repositioning.

A good bet

Traditional lenders favor self-storage properties for their steady cash flows and relatively low risk. Some 30 percent of tenants rent for more than two years and the delinquency rate for securitized self-storage loans is well below the average for securitized commercial real estate loans as a whole, according to rating company DBRS and the Self Storage Association.

The tenant base is as diversified as the populace, whether it’s a homeowner storing a bed frame or a boat, or a small business stashing its inventory of novelty socks. Borrowers have the option to turn to private lenders when they need capital quickly and are willing to pay higher interest rates for a relatively short term in exchange for speed and certainty of financing — such as an owner who needs to pay off construction debt on a property that isn’t yet fully leased up.

These scenarios could become more common if the economy goes into recession and conventional financing dries up. Typical interest rates on bridge loans of 10 percent to 12 percent offer investors attractive yields.

Robust activity

Self-storage facilities are no longer limited to rows of small, dingy lockers. Developers offer cold-storage and dry-storage facilities, light-controlled spaces for storing plants, as well as massive spaces to house vehicle fleets.

The boom in new construction of Class A self-storage facilities puts pressure on smaller operators to compete. Many are investing in expanding or repositioning their properties. Owners also are looking to lock in permanent financing as interest rates rise, and operators large and small are constantly on the lookout for properties to buy.

A developer in Hawaii, for example, turned to a nonbank lender for self-storage financing when local banks turned him down. He had leased about 120 abandoned caves on the island of Oahu that were originally built by the U.S. Navy to store munitions during World War II. He turned them into self-storage spaces. Three years ago, he decided to buy the sites and needed financing.

To finance the acquisition and planned site improvements, the developer borrowed $12 million at 11 percent for one year, with renewal options. The loan, underwritten at 83 percent loan-to-purchase and 54 percent loan-to-cost, closed within 30 days.

The property is now valued at about $75 million, according to the developer. He has already sold 20 of the warehouses to a mini-storage company. The developer is planning to sell the rest of them to construction companies and private companies that already are using them to store items, including cars, wine, equipment and even lava rocks — a valuable commodity in Hawaii.

Bulking up value

Borrowers typically need to show a property has a track record of producing income to qualify for conventional financing. It can take three to four years to bring a self-storage facility to stable occupancy, but the owner might need capital in the meantime.

Like landlords everywhere, self-storage property owners are adapting to keep pace with new technology. Savvy landlords are investing more in amenities, such as electronic-gate access, pest control and unit alarms, or sprucing up sites with fresh doors.

Many smaller owners also are trying to buy more sites and amass portfolios they might resell to a national operator or investment fund. Of the more than 44,000 self-storage facilities in the U.S., less than 20 percent are owned by the six largest publicly traded companies, according to the Self-Storage Almanac.

Publicly traded operators of self-storage facilities face perennial pressure to increase revenue. Acquisitions are one way, although it can be hard to find properties because many owners are reluctant to sell an investment that generates such dependable cash flow. If a buyer needs to move quickly to close a deal, private lenders can help facilitate that transaction.

Growing demand

In addition to the self-storage sector expanding through acquisitions, the big real estate investment trusts — such as Extra Space Storage and CubeSmart — increasingly are selling management services to smaller self-storage facility owners. The big operators have technology infrastructure that enables them to maximize revenue by improving online search placement and fine-tuning rental rates to shifting supply and demand.

Even Public Storage, one of the largest owners of self-storage properties in the U.S., announced this past February that it’s getting into third-party management in a bigger way. Having an experienced third-party manager on board can help a small self-storage owner appeal to lenders, many of whom are still new to the space and still getting familiarized with the property type. In addition, banks are generally becoming more cautious about the deals they make because of how far along we are in the commercial real estate cycle.

Self-storage properties, on a relative basis, however, do better during recessionary times than other property types. Even if the economy slows down, self-storage operators, like apartment landlords, have the flexibility to lower rents to keep units occupied. Americans like to consume and they like to hold onto their possessions. That means self-storage demand is likely only going to grow.


 
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