The self storage industry is posting returns that are whetting investor appetites for the property type. Yet building portfolios in what remains a highly fragmented industry is no easy task.
“There are a number of players that are kicking the tires and trying to get into it, but it is a matter of how to do it, because it is very hard to amass scale,” says Anne Coolidge Taylor, managing director at W. P. Carey Inc. Since 2006, the company has acquired 79 self storage properties spanning about 5.7 million sq. ft. W. P. Carey, which typically invests in net lease properties, likes self storage because of the steady cash flow and high margins, as well as the fact that the property type is fairly counter-cyclical.
But Taylor adds that growing that portfolio remains very challenging as more investors target the self storage sector. “There are a lot of interested buyers, and it has gotten quite competitive,” she says. The REITs and large buyers that already have a foothold in the industry are steadily working to expand their holdings. Self storage investment sales surged in 2012 to reach $2.1 billion—the largest volume since 2007 and well above the $1.5 billion in sales the industry has averaged over the last five years, according to Cushman & Wakefield.
“We’re seeing more investors at a time when there is less product,” adds R. Christian Sonne, executive managing director of Cushman & Wakefield’s self storage industry group in Irvine, Calif. The challenge is magnified by the fact that more than 80 percent of the nearly 51,000 self storage facilities in the U.S. are dominated by mom and pop owners.
Self storage company Storage Post and real estate investment management firm Heitman LLC recently made a splash with the purchase of 14 self storage properties in the New York metro area from Acadia Realty Trust for a reported $300 million. However, deals of that size are rare. One of the limitations of the self storage sector is that it is very difficult for an investor who has $500 million to invest to come in and quickly establish a position.
For example, Ladera Ranch, Calif.-based Strategic Storage Trust Inc., a nontraded REIT, has been very successful with its disciplined approach. But, even so, it took the company about five years to amass a portfolio of more than 100 properties. Strategic Storage Trust purchased two facilities in Mississippi in January for $10.7 million. Currently, the REIT owns 110 facilities in 17 states and Canada that are branded as SmartStop Self Storage.
Worth the wait
The self storage industry has typically flown below the radar screen. These days, the niche is attracting more interest from institutions, funds and private partnerships. “Self storage is not very sexy. It’s a pretty basic story,” says Sonne. “But I think that over time these strong metrics and fundamentals convince people that they need to take a look at the sector.”
In 2012, the four publicly traded U.S. self storage REITs posted a total return of 19.94 percent, according to NAREIT.
Because self storage tenants don’t have leases, owners can raise rents very quickly. Fundamentals also have been gaining ground due to record-low construction starts over the past five years. On a year-over-year basis, occupancies increased 1.6 percent in fourth quarter to hover at about 85 percent, while rental income increased 6.6 percent. “The metrics in the last year, particularly as it relates to operations, have improved significantly,” says Sonne.
Investors also like self storage facilities because they tend to perform fairly well in a down economy. Among stabilized properties, the average stay for a residential customer is close to two years and the average stay for a commercial customer is even longer. One property can have 400 to 500 individual tenants. So there is diversified cash flow, low volatility and low capital expenditures due to minimal eviction costs and no tenant improvement expenses. All of that adds up to a pretty attractive income stream, says Taylor.
Vying for properties
Competition is fierce, especially for stabilized properties. “Cap rates are pretty aggressive, largely because the underlying debt is so aggressive these days,” says Taylor. Cap rates during the second half of 2012 averaged 6.75 percent, which is down 55 basis points compared to the same period in 2011, according to Cushman & Wakefield.Competition is fierce, especially for stabilized properties. “Cap rates are pretty aggressive, largely because the underlying debt is so aggressive these days,” says Taylor. Cap rates during the second half of 2012 averaged 6.75 percent, which is down 55 basis points compared to the same period in 2011, according to Cushman & Wakefield.
It is very hard to compete for properties in urban locations in a major metro, such as New York City, where properties are selling for cap rates below 5 percent.
“Those go for such low cap rates that we can’t get enough yield for our investors,” says Taylor. “We feel that there are very strong deals, which have a terrific risk return in suburban and secondary and tertiary cities.”
In December, for example, W. P. Carey bought four self storage properties in Western Texas in Midland and Odessa for $33 million through CPA®:17 - Global, one of its nontraded REIT affiliates.
The investment capital pouring into the sector, coupled with improving fundamentals, would appear to be a perfect combination to fuel new construction. Certainly, development is expected to rise in 2013. However, securing financing for new projects remains a challenge.
In addition, many of the institutional investors, REITs included, don’t have the patience to put money into self storage construction. Even though self storage can be easy to build, the entitlements can take one to two years and then lease-up to stabilize properties can take an additional two to three years. For a cash-flow oriented REIT, that is a challenging scenario, notes Sonne.
The limited supply of new properties being built means that investors will continue to be stymied by the lack of available for-sale properties. For buyers such as W. P. Carey, that simply means working harder to find viable acquisitions.
“The trick is to find good markets that will perform well in the long-term that aren’t in the direct path of the public companies,” says Taylor.