‘The Shine Has Really Come Off’: Self-Storage’s Fall From CRE Golden Child To Mere Moneymaker
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Self-storage businesses were arguably the buzziest product type in real estate several years ago. Years of ramped-up development have since chopped returns in half, but even that isn’t deterring a generally optimistic outlook for the sector.
The self-storage sector has outperformed other asset classes this cycle and garnered interest from REITs that have shifted self-storage into more of an institutional operation. Demographic trends — 8% of the U.S. uses self-storage today, compared to 3% in the 1990s — limited capital required for upkeep and low supply in relation to demand has drawn institutional investors to the historically mom-and-pop-controlled sector.
The nearly 121% property value appreciation from 2010 to mid-2018 was the highest of all REIT sectors. But developers have also flooded the market with supply in pursuit of more customers, and that has taken a toll on rents that grew by double digits around 2015, according to Green Street Advisors.
“After two years of continuous increases in new supply, the shine has really come off storage,” Green Street Advisors Senior Research Associate Ryan Lumb said. “The excitement around the industry has turned into a pessimistic tone.”
Revenue growth that was once as high as 9% for some REITs in self-storage in 2015 is now closer to 3%, Lumb said. Street (standard) rental rates have fallen in 60% of the U.S. markets tracked by Yardi Matrix, with a 1.7% drop last month nationally for a 10x10 non-climate-controlled unit and a nearly 3% rent decrease for a climate-controlled unit of the same size.
Houston has seen a 6% street-rate rent drop in the last year due to overbuilding. The country’s fourth-most-populous city has more than 8 SF of storage space per capita, almost double the per-person supply of the third-biggest city, Chicago.
S&P Global Ratings issued a report earlier this summer saying it was cautiously watching the increase in CMBS loans in the self-storage space, due to the short-term nature of monthly rentals and higher level of supply delivering to market.
Self-storage projects account for 5% of all CMBS loans taken out in 2019, according to Trepp. That is up from a little more than 2.5% in 2018, but analysts aren’t concerned. The self-storage industry has among the lowest delinquency rate of CMBS loans, under 0.5% compared to 4.4% in retail and 2.4% for hotels, per the same Trepp data.
Despite the cautionary factors, investors are bullish on the market.
The five major REITs in self-storage – Extra Space, Public Storage, Life, CubeSmart and NSA – have occupancy rates of about 90%, said JLL Managing Director Steve Mellon, who leads the brokerage firm’s national self-storage team.
REITs typically cut rental rates dramatically, get a property leased up and then start raising rent, Mellon said.
Self-storage is generally seen as recession-proof due to sustained demand for storage space in positive and negative environments. Millennials continuing to rent homes far more than they own also leads investors to expect more demand for self-storage due to limited storage space in the typical apartment.
Self-storage also has significantly lower operating costs because there is less need for tenant improvement allowances like in office or multifamily projects.
“We joke how [tenant improvement allowance] is only $3 with self-storage: Grab a broom, sweep and then you lease it back up,” Mellon said.
Even with rents dropping this summer, the sector’s rent performance is still largely positive. Self-storage rents were up 30% in Q1 compared to 2009.
“We’re continuing to get growth out of a product type that once had double-digit growth. That earlier level isn’t sustainable,” Swerdlin said. “If you operate the property with some business acumen, I think we will always exceed GDP growth.”
Green Street anticipates the delivery of new self-storage facilities will peak in 2019, meaning institutional investors might not have to deal with fears of excess capacity for much longer. The sector will still have to exercise self-control to prevent another wave of overbuilding.
Green Street says 8% of the U.S. uses self-storage today, and it only anticipates a slight increase to 9% of the population utilizing the product in the future, in part due to younger generations preferring services to physical goods that need a storage unit.
“I still think the only issue right now is whether the industry can be disciplined in adding new supply,” Lumb said. “If 2019 is the peak of new supply, we will not see a lot of distress in the sector.”