Market Monitor

For the last several months we have been talking about the uncertainty in the self-storage investment market, due to stock market volatility, looming interest rate hikes, a new development pipeline, and the ever-changing financing market. By most measures the self-storage rental business is reasonably steady, if not booming today. However, over the last several years the self-storage industry has been able to grow and prosper because of its ability to continue to find “bolt on” revenue streams.

There are widespread expectations that the Federal Reserve will raise rates later this year; in fact, many think it’s going to occur next month. So exactly how will this increase in rates affect commercial real estate? The better question is why are interest rates rising?

Over the last 10 years, I have realized that complacency is a major problem in self-storage, particularly as we all have enjoyed the recent strong performance of the industry. At one time or another we have all looked at our to-do list and thought “I can do that next month.” Reviewing your operating expenses, however, is not one of those things you can afford to put off until next month.

Today we find ourselves in a unique position in the self-storage industry. Capital appreciation, combined with strong fundamentals, increasing demand and STILL low interest rates have made the traditional transaction more accommodating so that both the buyer and seller can achieve their goals without hurting the other party’s position.

With all of the hype surrounding self storage today, new development buzz, strong market fundamentals, fluid financing options and all-time high values, it’s worth contemplating; is this as good as it gets? For the last several months we have been talking about how long this cycle will last and the uncertainty of the major driving factors such as interest rates, amount of new development and overall market fundamentals. For now, all signs are pointing to GO!

I have suggested over the last several months that now is a good time to buy, sell, develop or refinance. Sounds good all the way around, RIGHT? Today’s strong market fundamentals and very liquid lending market have made good deals even better, and the cash on cash returns are simply staggering for owners, buyers and sellers alike. We have all seen the comparison of self storage to other real estate sectors over the last few years and in short, the returns are higher and the various risks are more moderate with the one exception: overbuilding.

Small and mid-sized investors have been very active in the self-storage space over the last 6-12 months. This is evident as Argus has transacted more sub-$5M deals over the last 6 months than any other period in our 21 year history of brokering self-storage transactions. No longer an afterthought in the industry, lenders are taking this segment of smaller deals more seriously. It is clear that these groups of investors are sophisticated and can analyze complex market situations and capitalize and execute a clear path to value creation. With more than 75% of the total self-storage transactions in the U.S. being less than $5M, this segment of the industry presents the greatest opportunity for investors to capitalize on the robust self-storage fundamentals that are present in today’s market.

Sometimes real estate brokers may forget that the details associated with a transaction may be quite unfamiliar to their clients when they decide to buy or sell self-storage properties. With this in mind, I thought I would take you through some of the behind-the-scenes aspects of a real estate transaction and focus on the due diligence requirements. Obviously, the devil is in the details in buying and selling a self-storage property and due diligence can separate the winners form the losers.

In 2014, more than $1 Billion of self-storage properties were sold. The majority of those transactions, 90% or more, were handled by a broker. Many self-storage owners who are considering selling or buying a property in the near future may wonder why so many people choose to use the services of a broker rather than handling the transaction themselves. The easy answer is that real estate clients believe they get value form using a broker’s services.

Looking back over 2014, most self-storage operators are continuing to bask in their own glory and in general, self-storage properties continue to perform better than expected. The last six months of 2014 were markedly different than the first few. Liquidity in the real estate debt and equity markets was supercharged over the last six months, pushing self-storage values to new record levels. It is clear that the art of real estate arbitrage is allowing buyers to achieve very compelling cash on cash returns, even while paying historically high prices.

As self-storage brokers, we spend a lot of time thinking about the value of self-storage properties. Our conversations are usually focused on interest rates, cap rates, timing of the real estate cycles, loan to value ratios, basis points, cost of capital, net operating income (NOI) and lot of other topics that rarely interest property owners other than when they decide to buy or sell a property. There is a good reason most owners avoid this terminology on a daily basis: they are running a storage business! However, we believe that there is a connection between understating the nuances of what does and does not create value and running a successful business.

Here comes the self storage development train. After living through two booms and two busts in my real estate career, it has become clear that real estate peaks and troughs are very much accelerated by the development of new product which typically begins near the middle of the real estate cycle.