Investing in Self-Storage Facilities
Commercial real estate is made up of several different kinds of property types. In this article we look at self-storage facilities, a fast-growing sector that has taken advantage of a growing market of persons needing to store excess household items.
Self-storage businesses offer space-strapped customers a secure place in which to store things they don’t need right now, but can’t bring themselves to throw away. These facilities have become big business; nearly 1 in 10 American households uses one of about 50,000 self-storage facilities. The sector has generated more than $22 billion in annual U.S. revenues, and rentable space now totals more than three times the size of Manhattan island. Television shows like “Storage Wars” and “Auction Hunters” have grown out of the phenomenon.
The business model is unusual for commercial real estate. Self-storage facilities can be in unglamorous locations – noisy roads or the outskirts of town are fine. Tenants pay little or no deposit, and are free to leave at a moment’s notice. Nevertheless, it’s a sector that has recently seen robust performance and growth that was slowed only slightly during the recent recession.
Two primary factors influence the business. First, people continue to acquire things that can’t be consumed – furniture, toys, numerous knick-knacks – and, for various reasons, they are hesitant to, or can’t yet, throw these items out. The recent recession hurt the sector only slightly; displaced homeowners often moved to apartments or smaller homes and still needed to store excess household items. Second, despite the short-term nature of the rental contracts, people are reluctant to finally deal with – and throw out, or at least clean out – the items they’ve placed in storage. Stored stuff is like a bank deposit – it usually stays where it is. Estimates are that one-third of storage space is filled with items that have been there for over three years.
Because the tenant base at these facilities is large, owners are protected from the long-term vacancies that can sometimes occur in other commercial real estate categories. The short-term nature of the rentals also allows owners to quickly react to market conditions.
People use self-storage for many different reasons, including household downsizes, renovations, relocations, military posts, and for holding business records. Some of these motives become more prevalent during economic downturns, lending a counter-cyclical feature to the sector. Moreover, because people are slow to leave these facilities once they’ve rented space, turnover is less of an issue than the short-term contracts might lead one to expect. Finally, the large number of rentable spaces in most facilities also means that owners are not vulnerable to large swings in vacancy rates.
Self-storage facilities are relatively low-maintenance; a clean sweep after a tenant has vacated and the space is ready for the next renter, and there is typically no need for tenant improvements or leasing commissions. Until the recent recession, operators rarely had to do much marketing; that has now changed, and knowledge of internet marketing techniques is becoming a big factor. A manager usually needs to be on-site during the day to handle new leases, and security guards, alarms, or cameras are usually employed during evening hours.
Like other real estate asset classes, self-storage facilities can be classed as Class A, Class B, and Class C properties. Location and the physical condition of the building remain primary factors in this assessment, with the population inside of a few-mile radius serving as the target demographic. Development of new properties has been extremely limited over the past five years, aiding the recent pricing stability for existing properties. Owners have, however, begun to compete on the basis of other enhancements, including:
Nearly 80% of self-storage properties remain in the hands of small, independent investors. The sector’s solid past performance has begun to capture the attention of large institutional investors. Larger properties in particular are increasingly the subject of interest from institutional buyers, including the larger self-storage companies that run themselves as real estate investment trusts (REITs).
The investment community has recently taken notice of self-storage as a viable commercial real estate asset class, and the underlying dynamics continue to fuel the sector’s success. It may not last forever, but with solid recent past performance and upward trending occupancies and rental rates, self-storage is currently a real estate rising star.