Self-Storage Industry Outlook
This blog post comes to us from Brad Sherman. Brad Sherman has primary responsibility for all legal, investment and finance matters for StoreSmart®, an operator of self-storage facilities. He is an accomplished real estate and corporate lawyer and has over 20 years of experience investing in, or developing, numerous retail and single-family real estate developments. Below, he shares his insights on the self-storage industry.
Even during the Great Recession of 2007-2009, self-storage outperformed all other asset classes of commercial real estate. Self-storage has only experienced an actual loss rate (foreclosures) of about 2%, by far the lowest of all commercial real estate asset classes.
Market Segmentation. Generally, all self-storage projects fall into one of the following market classifications:
Class A. StoreSmart® competes in the Class A segment. Class A facilities generally have superior locations and access in order to attract the highest rent payers in the market. Class A facilities utilize the highest quality construction and have on-site managers, often living at the facility. These facilities typically have higher maintenance and security and offer some climate-controlled units. StoreSmart®’s competitors in this segment include all of the self storage REITS such as Public Storage, Sovran, U-Store-It, Extra Space and numerous regional self storage chains.
Class B. The Class B segment includes facilities with good-to-average rental rates, locations, security and maintenance. Class B facilities generally compete and the lowest end of the Class A spectrum. These facilities often have on-site or competent off-site managers.
Class C. The Class C segment includes facilities with secondary, less desirable locations relevant to tenant needs. These facilities typically have limited access and visibility and usually have considerable deferred maintenance. They will usually have minimal or no security and may not have an on-site manager.
Fragmented Industry. Despite the considerable M&A and consolidation activity, the self-storage industry remains highly fragmented nationally. The top 10 operators control approximately 16% of the facilities, the next 11-50 operators control approximately 6.5% of the facilities and with the remaining approximately 77% of the facilities controlled by independent owners. This fragmentation should provide for the opportunity for well
capitalized and sophisticated players to selectively target individual assets and portfolios at attractive cap rates thereby enabling these players to amass attractive portfolios of assets and emerge as large industry players.
Strong Year-Over-Year NOI Growth. In-place self storage tenants are generally not price sensitive, as the self storage rental fee is normally a small portion of a tenant’s disposable income. In addition, there is minimal communication between different tenants at a given facility, which allows for the operator to selectively adjust rental rates for individual tenants. These two factors combined allow for the operator to increase rates to market on an ongoing basis for in-place tenants and to maintain a relatively high year-over-year rental rate growth. This captured in-place demand is one of the main reasons large self-storage operators are able to, in general, increase rental rates by 5–12% annually.
Cash Flow Diversity. Self-storage revenues are inherently diversified by tenant and facility, somewhat analogous to the multi-family sector. Since most self-storage facilities offer monthly leases, when market demand rises, prices can be increased at a faster pace than other real estate asset classes with longer term, in-place leases. That said, in the event of an economic downturn the opposite effect is a risk, which is mitigated if limited supply exists. The cash flow is further diversified by a widely unrecognized robust commercial customer base to complement self storage consumer tenants. These commercial tenants help support occupancy levels, lengthen rental terms and further diversify the tenant base.
Minimally Sensitive to General Economic Shifts. The self-storage industry is more insulated from economic shifts as the need for space exists both when the economy is weak (as people downsize in housing, double up or move in with parents) and when the economy is strong (more disposable income and purchased goods requiring storage, as well as heightened demand for commercial users). Consequently, self-storage facilities are generally hold value better and recover more quickly if real estate markets sour, creating a hedge to weakening markets.
Metrics Outperform Other Real Estate Sectors. While office and retail sectors have experienced significant increases in vacancies nationwide during the Great Recession of 2007-2009, self-storage rental rates have risen, indicating relatively strong demand for the product. While there are no direct indices of delinquency rates across the self storage industry, increased rental rates reflect strong occupancy levels.