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Self Storage Strategies

Development opportunities dwindle

The great era of self storage development in the United States is over, and investors should focus on acquiring existing properties and squeezing every bit of upside out of them, according to several industry experts.

"Investors need to look for locations on good dirt and maximize value either by expansion or improved operations," suggests Michael Scanlon, president & CEO of Alexandria, Va.-based Self Storage Association. He says self storage construction activity is slowing down across the nation because "it's tougher and tougher to find good dirt to build on."

Instead, many investors are buying older facilities that are a little worn. They're cleaning them up and taking them from a C property to a B property by installing state-of-the-art security, new lighting and blacktop, and perhaps even a retail store that sells boxes and tape. Other investors are finding properties with extra acreage or ones that can be expanded by building up.

Consider Stiles Lake Investors LLC – the Manhattan-based self storage owner and operator recently acquired a 27,000-square-foot self storage property in central Massachusetts in an off-market transaction.

"This is a classic mom-and-pop facility," notes managing member Morgan Hanlon. "It's small, but it has some room for expansion. And, the upside for us is integrating facilities into our current operations and bringing some institutional management practices."

Too much stuff
The rush for value-added opportunities has already started, with self storage investors of all sizes looking for existing cash flow and a bit of upside later on. "There's opportunity in this industry," Hanlon notes. "A lot of people are finding that they can't live without storage – they own too much stuff and do too many things. "

In fact, demand for self storage space has mushroomed, and the self storage industry has been the fastest-growing sector of the U.S. commercial real estate industry for more than a decade. Over the past 12 years the number of households using self storage has increased about 65 percent. Today, nearly 1 in 10 U.S. households, or 10.8 million households, currently rent a self storage unit, an increase from 1 in 17 U.S. households in 1995.

"What we used to think of as a short term solution for the three Ds – death, divorce and disaster – is now something that people are using all the time," says Nick Malagisi, an advisor with Sperry Van Ness who recently sold a four-property portfolio in Philadelphia to Miami-based Simply Self Storage for more than $30 million.

Americans, unlike most people in the world, are very mobile: 14 percent of all Americans moved last year. "That's the meat and potatoes of the self storage industry," Scanlon says.

However, Scanlon notes more and more people are using self storage to hold all equipment from their leisure activities. From canoes and tents to ATVs and fishing rods, self storage units are a place to put everything that "won't fit in the garage," he says.

In 1996, there were only 25,180 self storage properties in the U.S.; there are now nearly 60,000 self storage facilities totaling 2.2 billion square feet. Moreover, the total market capitalization value of the entire U.S. self storage industry is well in excess of $220 billion, and self storage facility gross revenues for 2006 eclipsed $23 billion.

Small operators dominate
Despite its growing sophistication and increased acceptance in residential areas, the self storage industry continues to be dominated by small and regional operators. In fact, the top 10 largest self storage owners and operators – including the four REITs – only account for 11.6 percent of the overall market, according to the 2007 Self Storage Almanac. (The four REITs are Public Storage, Extra Space Storage, Sovran and U-Store-It).

The industry's fragmented ownership sets the stage for value-added investment opportunities, Scanlon contends, especially for regional operators. He refers to this group as "consolidators" because they buy properties, fix them up and sell them to larger operators, primarily REITs.

Today, REITs are primarily interested in buying stabilized properties in core markets – the A properties in major markets like Boston, Chicago and Los Angeles, says Jim Stevens, senior vice president of acquisitions for Extra Space Storage. So far this year, the Salt Lake City-based REIT has acquired $250 million worth of assets including 11 in the Bay Area of Northern California.

Individual operators and small regional players, on the other hand, are focused on secondary and tertiary markets. "There is less interest from the big guys in tier two and three geographies – there's just less competition," says Hanlon of Stiles Lake Investors, which owns eight properties in the Northeast. "If you pick your spot and pick your properties, you can find decent assets where there's some upside and you can get them at a decent price because you're not competing with those guys."

Last year, roughly $1 billion worth of self storage assets traded hands, according to Malagisi. The average cap rate for properties sold during september 2006 to December 2006 was 7.65 percent, according to Self Storage Data Services.

Malagisi expects volume to be similar for 2007. Historically, investment in self storage has grown significantly – in 2005, for example, about $600 million in self storage properties traded hands in the U.S., nearly twice the amount sold in 2004.

Specifically, prices have increased significantly in the Western part of the U.S., pushing cap rates to a nationwide low of 6.8 percent, according to Adam Petriella, a director with Marcus & Millichap Capital Corp. Another notable change has occurred in the South Central region where the median price has soared 52 percent to $57 per square foot. Similarly, the median price in the Northeast has jumped 48 percent to $103 per square foot, although cap rates have softened a bit to 7.5 percent.

"Over the last 18 months there's been [upward] pressure on cap rates and going forward I think there is a chance that cap rates will stabilize or even bump up a little," says Extra Space's Stevens, noting that the REIT is buying properties at cap rates ranging from high 6 percent to low 7 percent. "Sellers can still command a decent price for their properties, but going forward I think it will become more in equilibrium."

Still, competition for self storage assets is fierce, and it's coming from some new and unexpected places. "We're now finally beginning to see some investors cross over from other real estate sectors," Malagisi notes, pointing to Simply Self Storage's partnership with mall REIT Simon Property Group.

Moreover, institutional investors have changed their self storage investment strategies. "Institutional money has come into self storage in an interesting way," Malagisi notes. "Institutions used to own the properties, but today most of them are investing through joint venture relationships with established operators." He says he has several clients that have partnered with institutions to expand their portfolios.

Similarly, Hanlon is debating whether or not he wants to raise additional capital to increase Stiles Lake Investors' portfolio. Although he is considering joint ventures with institutional capital, he's not sure how he wants to proceed. However, he is sure he will continue to invest in self storage. Quite simply, "it's where we want to be," he says.

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