As other commercial real estate sectors struggle to adjust to a changing world in the wake of the pandemic, the self-storage industry continues to perform at its predictably high level. While some may see it as the least sexy of the CRE asset classes, self-storage has consistently delivered solid returns no matter how turbulent the markets. During the 2008 Great Recession, self-storage was the only REIT sector to post positive returns, continuing to outperform all other asset classes during the 10-year period from 2009-2018 (averaging an annual ROI of 16.9%). That level of consistency has continued even as the pandemic has wreaked havoc on other asset classes.
“Our industry has proven to be not quite recession-proof, but certainly recession resistant,” says Nick Malagisi, SIOR, national director of self-storage for Buffalo, N.Y.-based SVN Commercial Real Estate Advisors. “Nobody was moving in during the pandemic, but do you know what? Nobody moved out either. And when the CRE industry found out, all of a sudden demand for the product type began picking up.”
The pandemic proved to be a serendipitous boon for the industry, as companies turned to a work-from-home strategy—first by necessity during lockdowns, then by employee choice—so the need to carve out space at home for home offices or gyms drove workers to seek out storage space. “Nobody could have predicted what would happen during the pandemic, let alone after it,” says Malagisi. And as employees embraced the work-from-home ethos, they soon realized that remote work would also allow many of them to relocate to areas with lower housing costs and still do their jobs. “There used to be what we called the three D’s of self-storage: death, divorce, and (natural) disasters, and we’ve added a fourth—displacement, meaning people moving,” added the 30-year self-storage veteran.
Millennials, now the largest working population in the U.S., are much more mobile than preceding generations, and 45% say they are very likely to use self-storage during a move. The predominant reasons given by renters for using self-storage are moving (42%) and a lack of space at home (31%), according to a recent survey by RentCafe. Both are connected to the pandemic-driven shift to remote work. Consequently, occupancy rates at self-storage facilities nationwide climbed from 91% in pre-pandemic 2019 to 94.5% in 2021. And although demand slowed slightly heading into the fall, that was offset by average U.S. street rates rising to all-time highs (in June) for both 10x10 climate-controlled units ($132) and non-climate-controlled units ($150), according to Yardi Matrix.
Our industry has proven to be not quite recession-proof, but certainly recession resistant.
The continued strong performance of the sector has private equity and institutional investors doubling down on acquisitions in recent years, with REIT CubeSmart acquiring a 59 asset portfolio in December of 2021 for $1.69 billion, and National Storage Affiliates Trust (also a REIT) acquiring 229 properties for $2.2 billion in 2021 in multiple deals. Over $15 billion of self-storage properties were traded in 2021, more than double any previous year, as asset pricing hit an all-time high of $122 per square foot, according to Marcus & Millichap’s 2022 National Self-Storage Outlook report. But it’s not just institutional money chasing assets: small businesses and mom-and-pop operations still represent the vast majority of operators of self-storage properties—as high as 80%—Yardi research indicates.
The increased demand for self-storage, coupled with its low overhead and relatively predictable expenses, has also spurred an increase in development. Currently, over 131 million square feet of new storage space is planned or under construction throughout the U.S., which will increase the existing inventory of 1.6 billion square feet of rental storage (over 50,000 facilities) by over 10%, according to Yardi’s data.
MUNICIPALITIES SAYING 'NO' TO DEVELOPMENT
As enticing as the prospect of developing new product may be, there are a number of existing and emerging obstacles to overcome for those looking to cash in. One of the major hurdles, according to industry insiders, is gaining approval from municipalities, which have become increasingly resistant to the product type in recent years.
Jumbo Capital, a Massachusetts-based value-add investment firm with a 4.5-million-square-foot portfolio valued at nearly $1 billion, chose self-storage when it ventured into the development business in 2015. “We decided to start with self-storage because it seemed to be the easiest execution for development, and that was a little naïve, because although the structures are easy to build, some towns don’t want them,” says Jay Hirsh, managing partner and founder of Jumbo Capital. Hirsh found that while some communities were comfortable with the product type—understanding that self-storage could increase tax revenue without creating any demands on the municipality’s school systems or utilities or the police—other towns perceived a stigma attached to self-storage.
Hirsh adds: “It took a little while to figure out the right recipe for sites and what towns were receptive to this use and which towns weren’t, but eventually we figured out where we could entitle the projects, and we started to develop.” Jumbo has built five self-storage facilities and sold them all, including a pair of newly completed, multi-storied,1,000-plus unit facilities to Dallas-based Baranof Holdings for a combined $54 million in late 2021/early 2022.
“It really has become more challenging to get a storage facility approved,” says Patrick Byrd, principal and co-founder of Focus Commercial Real Estate in Bentonville, Ark. “Cities typically want them in industrial areas where people aren’t—and developers want them as close to the rooftops as possible.”
Byrd says the reasons communities give for objecting to development of self-storage are myriad, beginning with the misconception that self-storage facilities devalue the surrounding properties. Self-storage facilities are also not usually considered to be the highest and best use of land by city planners, who prefer more housing or product types that stimulate economic development in communities. And while self-storage may put minimal stress on a town’s resources, they also don’t generate many jobs or as much in tax revenue (except property taxes) as retail and other property types—all of which discourages planning and zoning boards from approving self-storage projects or relegating them to specific zones, such as industrial areas.
“Keep in mind that most storage users (an estimated 10% of U.S. households use the service at some point) want to be within 10 minutes of their home,” says Butch Gurganus, SIOR, president and co-founder of Focus Commercial Real Estate in Bentonville, Ark., who works hand-in-hand with Byrd on the firm’s self-storage deals. “Homeowners typically don’t want self-storage next to their neighborhood, but are your first customers when you open. If self-storage is developed thoughtfully, it can add intangible value for apartment and subdivision developers by providing a service for use by the surrounding residences.”
There is also the issue of aesthetics, as the image associated with storage facilities is often one of single-story metal buildings with roll-up sheet metal doors, rather than the well-designed multi-story facilities favored by institutional developers today. “Some cities are now requiring developers to build storage units that don’t look like storage units,” says Gurganus, and the old “form follows function” rule does not apply to many of the new facilities.
One way that developers are getting new facilities built is by adapting Big Box stores. The concept is not new, as Marcus & Millichap tracked 12 million square feet of adaptive re-use development in 2019 and another eight million in 2020, but the practice continues to gain traction, according to Gurganus. Decimated by the change in consumer habits during the pandemic, empty Big Box stores feature warehouse-like interiors that are relatively easy to convert to class-A self-storage facilities with climate control, and many of these existing properties have large parking lots that can be used for RV and boat parking.
INTEREST RATE HIKES MAY SLOW DEVELOPMENT
Another threat to development may arise as lenders anticipate a recession, which seemed increasingly likely at press time following multiple rate hikes by the Federal Reserve. Banks are responding to the rising rates by reducing the amount of leverage they are willing to provide. In conversations with developers, Malagisi learned that deals that once featured 70% loan-to-cost ratios are being lowered to 65% or 60%, with some transactions seeing high bidders drop out as a result.
In good times and in not-so-good times, people need storage.
“So anybody that was thinking of building self-storage, or just got their approvals, has seen their construction pricing increase, because their carrying cost has changed dramatically,” Malagisi observes. “What has kept a lot of people out of our industry is the long lease-up time. We program 60,000 net rentable square feet for 36 months to get to 85%-90% occupancy, so the carrying cost is tremendous.”
The rate hikes may also slow down the trading of properties, says Byrd. “I think it’s going to be harder to buy assets, because a lot of people bought storage units with inexpensive money that they borrowed. They’re not going to be interested in selling right now, because rents are going to increase, followed by a decrease in property value.”
Even with the headwinds facing the industry, Malagisi believes that self-storage will weather the storm and continue to produce robust returns, “because in good times and in not-so-good times, people need storage.”
This article was sponsored by the SIOR Foundation - Promoting and sponsoring initiatives that educate, enhance, and expand the commercial real estate community. The SIOR Foundation is a 501(c)(3) not-forprofit organization. All contributions are tax deductible to the extent of the law.
Nick Malagisi, SIOR
Butch Gurganus, SIOR