Market Monitor

One of the most common themes in my conversations with clients has always been the market valuation of their property and outside factors affecting the investment market.  New supply, softening rental rates and rapidly rising real estate taxes have been at the forefront of these conversations over the last few years. Today, however, investors have much more on their minds with the election less than 60 days away, a global pandemic unfolding, and capital gains tax and 1031 exchanges under close review.  Now, more than ever, owners need to be reviewing their self-storage investments to make sure they are protecting their valuation.  The slow creep of rising operating expenses has put undue downward pressure on NOI growth; a trend that can be seen industry-wide as the five major REITs have reported NOI declines for more than five consecutive years. A small but meaningful review of your operating expense might be the most important in years as we are finding that it is easier to dig in and cut operating expenses rather than grow revenue under today’s market conditions.

The summer of 2020 has been unlike any we’ve known in the past, but fortunately, the self-storage rental season and investment market are alive and well. Despite the stock market’s recent performance and the self-storage rental season showing signs of strength within our industry, I am not confident that the market disruption and recession are over. Please forgive my skepticism, but I am concerned about the lagging effect of historically high unemployment, the impact of disrupting the traditional school schedule, the ever-changing debt markets, and the impact of an election year. The reality that come November we might have a new administration saddled with a tremendous amount of debt, and one that sees the world in a totally different light should not be taken lightly.

The second half of 2020 is upon us and it is now abundantly clear that the COVID disruption is not going away and, in fact, may be just the tip of the iceberg in terms of the problems facing the economy today. In total, nearly 33 million Americans were getting jobless benefits as of June 20th, about five times the peak during the Great Recession. Things have improved since new claims peaked in late March, but spiking coronavirus infections around the country and expiring federal aid means layoffs could increase in the coming months.

It is clear that there is a disconnect between Wall Street and the main street economy. Many unemployed individuals may soon see a large drop in household income as the $600-a-week federal supplement to unemployment benefits enacted early in the recession is scheduled to expire after July 31, barring an extension from Congress, which seems unlikely given opposition. Meanwhile we have seen the stock market reach near pre-recession/COVID levels.  I simply don’t see how we can avoid more economic hardship until the country is fully open for business and unemployment is back to more historical levels. We have to believe that some of nearly 33 million unemployed Americans are storage tenants.

Over the last several months the self-storage investment landscape has changed dramatically, largely due to the COVID disruption. We are clearly in an unprecedented time for the self-storage industry where the unconventional and unexpected have become a part of everyday business.  As we start to collect data from the industry’s performance over the last 3-4 months, it is clear we are doing better than most commercial real estate and we should all be very thankful that we are in the self-storage business. However, the valuation, transaction velocity, and overall fluidity of the self-storage investment business has been impacted.  With that in mind, I have tried to touch on a few topics that have changed during the COVID disruption so that you can better understand how self-storage transactions are being structured today and the associated strategies that are being employed.

After 10+ weeks of quarantine we are starting to settle into the new reality of navigating the investment market in light of the COVID disruption, and it is clear that this is going to take a while to work its way through the system. Like many of you, I have been watching the volatility in the stock market closely in recent weeks as uncertainty surrounds the investment market. Additionally, Argus has been collecting data points with regards to operating metrics, self-storage investment pricing and self-storage market sentiment. On May 13, 2020 we held a webinar with some of the most active and well-respected self-storage professionals in the industry. We held off on hosting a webinar until we could provide real market data points to share with the group and offer real guidance to our clients in these volatile times. Below I have summarized the key takeaways from the session, and if you would like to watch a recording of the entire Q&A please click here. If you have any questions or would like to follow up with any of the panelists, please reach out to your local Argus Broker.

Like many of you, I have been watching the volatility in the stock market closely in recent weeks as uncertainty surrounds the COVID disruption, the new CARES Act and how effective it will be.  I’m still not sure if it is a good idea or a bad idea, but I am concerned about the overall market and the fact that real estate loans are getting tougher to find. After twenty-plus years in the real estate business I thought I had seen everything that a market could throw at us, but this time it has thrown everything at once!

The economic environment of the last several weeks has been devastating not only to the stock market but also to the commercial real estate market.  Few self-storage owners realize the full extent of the devastation this market disruption has had on self-storage projects because unlike the stock market, there are no daily quotes to tell you what is happening in the self-storage world.  While I can’t tell you exactly how much your property value has declined, I can tell you that the average property value is down between 0%-25%, simply based on the change in market sentiment and investor confidence. If your revenues are down as well, the value will also be down by roughly the same percentage as the revenues in addition to the above declines.

WOW! There’s never a dull moment in this world. First and foremost, it is our hope that you and your families are staying safe and healthy during this unprecedented time. Due to the coronavirus we suddenly find ourselves in a situation that we have never dealt with before and there are many questions for which we have minimal answers at this time. The acceleration of overall anxiety in the past two weeks related to the coronavirus has made most recent economic reports irrelevant. The financial shock that markets are experiencing is likely to weigh heavily on economic growth prospects for at least the next few quarters. The one thing that I DO KNOW is that we will get through it.

Because of our common interest in the self-storage industry, I want to share with you some takeaways, resources and thoughts from the last few weeks’ activity. Argus is the only full-service self-storage advisory firm that includes third party management, investment sales and advisory services, so we have a unique perspective that is all-encompassing for self-storage owners. Below we have tried to touch on some key points regarding the investment markets and also provide some tips for self-storage owners and operators. If you have questions about how we are handling any part of our business during these unprecedented times, please don’t hesitate to reach out and we will provide you with guidance and resources.

The first few months of 2020 have seen the capital flow of both debt and equity increase, but there is a significant bifurcation in the self-storage investment market in valuations between stabilized assets and newly developed assets in lease up.  Today, stabilized assets are commanding all-time high pricing while newly developed lease up properties are experiencing some softening in pricing. This is reinforcing the fundamental fact that self-storage is still a cash flow business and 90% of value is created by your NOI and free cash flow.   This is largely driven by the current debt markets and the investment community’s strong desire for yield and assets with low capital expenditures, such as self-storage.

As we enter this new decade in 2020, Argus is celebrating its 26^th year in business. In that time, we have learned a great deal about what makes a successful self-storage investment. We have seen a lot of changes in the self-storage industry over these 26 years, most notably the tremendous expansion of more than 20,000 self-storage properties being built, accounting for nearly half of the existing properties in the market today.  We have witnessed the once sleepy “Mini Storage” business growing in to an institutional and tech savvy industry with large multi-story projects springing up on the corner in every major MSA around the country.

The last decade was a remarkable one for all investors. Stock markets soared and the global economy, though threatened, remained resilient while one incredibly volatile investment stood out from all the rest as the best of the 2010s. Want to guess what it was?  Bitcoin. According to a recent report by Bank of America Securities, if you invested $1 in bitcoin at the start of the decade, it would now be worth more than $90,000. As we move into the next decade, investors face a new set of obstacles—from trade wars, to elections, to recession concerns.  How will the investment market perform? And more importantly, how will the self-storage industry perform over the next decade?

In 2019, the biggest lesson we learned is that self-storage is not bullet proof.  We have seen new deliveries continue to push down rental rates, occupancies and revenue growth.  New development continues to be highest in markets with strong employment growth, which leads to outsized population growth and overbuilding. We are stating to see this spill over to the secondary markets but at a very moderate pace.

As we enter the 4^th quarter of 2019, self-storage investors are achieving higher than normal returns and extending the valuation push during this unprecedented real estate cycle.  Many investors are finding that real opportunity lies in the arbitrage a real estate investor can capitalize on between cap rates and interest rates.  While the word arbitrage is usually thought of as high finance concept, there are some viable opportunities that might be available in the self-storage investment market today.  The term arbitrage mans that an investor can take advantage of some pricing or other discrepancies in the marketplace.  For example, if a stock were selling on the London Exchange for $50 and on the New York Exchange for $55, it would become clear that you should buy in London and sell at the same time in New York. Do it once and you are entitled to call yourself an Arbitrageur (even though it sounds French, don’t let it go to your head). Now that you understand the basic concept, how can we make arbitrage work for us in the self-storage marketplace?