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Why Self Storage Is Steady Despite Economic Bumps

The next two years are set to provide an extended window of investment opportunity, according to experts.

Source: Multi-Housing News, By: Jeffrey Steele, August 22, 2022

The reputation of self storage as a comparatively recession-proof sector boils down to “The Four Ds.” Downsizing, displacement, divorce and death all spur folks to pack possessions away. In good times, these drivers propel the growth of the self storage industry. In bad, such as the arrival of the COVID-19 health and economic crisis, they can supercharge its growth.

To The Four Ds, add a fifth, “Diversity,” because self storage is built for so many different life scenarios. It’s there when folks relocate, when younger adults need to move back in with parents, and when seniors transition to assisted living after a spouse’s death. Because such events were more commonplace during the pandemic, it’s fair to declare self storage a countercyclical investment play. That’s a big reason many sector experts believe self storage is a recession-resistant industry.

It also explains why the industry is in the early stages of its latest development cycle. Six years ago, the sector found itself in the midst of the largest development cycle in its history. Development slowed in 2018 and 2019 as the industry endeavored to absorb the amount of supply added, and entered the seventh inning of that cycle.

“But with COVID, people had to free up space at home, and were moving across country,” said Cory Sylvester, principal of DXD Capital, which launched DXD Storage Fund I to pursue self storage development. “In 12 months, we went from oversupply to undersupply, and the start of the next development cycle.”

Pricing soared skyward in 2021, up 66 percent according to Green Street Advisors. The mushrooming growth can be attributed to multiple factors. Double-digit rent growth and record-high 95 percent occupancy rates across the country brought about a 16.5 percent NOI increase last year. Simultaneously, cap rates have compressed 110 basis points since the arrival of COVID-19, falling to 4 percent nationally.

“Self storage ranks right at the top, alongside industrial, as one of the best performing of all property types over the past two years,” said Ian Formigle, CIO of CrowdStreet.

Geography lesson

Each year, an ever-larger percentage of the American population uses self storage. That drives increased demand.

The best sites are near where people are moving. Top 10 metros for highest occupancy rates are disproportionately found in the Sun Belt, as are metros with greatest quarterly rent growth. Units measuring 10 by 10 continue to be the most popular, and whether climate or non-climate controlled, self storage performs best where demographic shifts are occurring, among them aging populations, corporate headquarter relocations or more mobile workforces, said Ermengarde Jabir, economist with Moody’s Analytics.

Chart and data courtesy of Moody’s Analytics

Some also anticipate greater sector growth within major university cities.

Another key is to seek populations demographically well-suited for self storage within 5 miles of the proposed site of a new facility. “Studies have shown people don’t want to travel more than (that) to store their belongings,” said Michael Margarella of Next Play Investments LLC, who with a partner owns and operates three Midwestern facilities, and will soon close on a fourth.

When eyeing development, some look for growing metros with comparative lack of supply, defined as five square feet or less of self storage space per capita in the prime market areas. Development and adaptive reuse projects alike profit from an unusually wide spread between usual stabilized yield on cost at stabilization —typically ranging from 7.5 to 8 percent—versus the typical exit cap of a fully stabilized self storage property, approximately 3.5 to 4.5 percent. The large spread may allow a sponsor to sell a stabilized self storage facility for 40 to 45 percent more than the building costs.

“However, in addition to more general risks such as high vacancy rates, oversupply of product in the market and tenants’ credit quality, another factor . . . (is) sensitivity to rent increases, especially if there is competition nearby,” Formigle said. “Tenants may opt to move out in order to save on storage costs.”

When it comes to rich acquisition opportunities, a desirable self-storage type may be Class B, or older properties whose non-professional managers have failed to keep tabs on the extent to which the industry’s rents have surged in the past 18 months.

Because leases are typically month to month, an acquirer can increase rents and see instant gains, said Steve Mellon, managing director, capital markets at JLL Houston.

What’s ahead

The next two years may bring a tug-of-war between investors and developers, and between higher returns and capital’s appetite for storage investment. Replacement cost has grown substantially, the result of higher interest rates, limited labor supply and supply chain issues. “Thus, the development of storage is muted,” Mellon noted.

Several other factors underpin the health of self storage. Workers are more mobile due to remote work opportunities. Small retail operations are seeking self storage to use as warehouse and distribution space for goods as they are priced out of the traditional industrial market. The sector will also likely benefit from inflationary effects.

“People (are) either relocating to lower cost-of-living areas, or leaving areas with low wages in search of higher wages in a labor market favoring employees,” Jabir said.

A predicted delivery downturn through 2024 should be trailed by growing construction deliveries in 2025 and beyond, due to increasing demand for self storage. “To us, this suggests that the next two years may provide an extended window of opportunity to invest in the sector and re-evaluate our strategy as we approach 2024,” Formigle said.

Ultimately, the greatest harbinger of excellent long-term sector growth is the never-ending, all-too-human tendency to let things slide. “Everyone gets their things into storage thinking, ‘I’ll use this for a few months,’” Sylvester mused. “A few years later, they’re trying to remember what they put (there).”

Source: Multi-Housing News, By: Jeffrey Steele, August 22, 2022

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