By Kenneth E. Nitzberg
If you look at the market for the sale and purchase of self-storage assets today, and youve been in the sector since at least 2005, at first blush, it would be difficult to tell whether you were in the summer of 2007 at the height of the self-storage market frenzy or if it is really the summer of 2013.
We are once again seeing capitalization (cap) rates for class-A self-storage facilities hit 6 percent and sometimes even lower. If it's a class-A portfolio for sale, its likely in the 5 percent range. Its a great market if youre a seller and have a class-A facility in a major metropolitan market, but its a very difficult time to be a buyer if you have funds to place in the self-storage asset category.
So whats going on with the market? I believe there are three factors at work, the combined pressure from which is continuing to drive market cap rates down, thereby driving up prices.
Interest Rates
The first leg of the three-legged stool is interest rates. They have continued to fall. With the much greater availability of significant amounts of debt, the combination has driven up prices buyers can justify paying. Although interest rates have again moved up almost 100 basis points in the past 60 days, theyre still at or below historical levels of the past 20 years.
Commercial mortgage-backed security (CMBS), fixed-rate, 10-year loans are available in the high 4 percent to low 5 percent rates. Simply put, interest rates at this level can make marginal acquisitions look a great dealbetter than they may actually be. Are we as an industry selling self-storage facilities or large amounts of real estate lipstick to make the product look better than it really is?
Recovery
The second leg is the recovery that has taken place in the self-storage sector. Over the past three years (beginning in 2010, after the crash in the fall of 2008 with the demise of Lehman Bros. Holdings Inc.), weve seen occupancies rise significantly. For the first time in more than five years, the industry can now raise rates fairly significantly without fear that it will cause a stampede of move-outs. This has dramatically increased revenue and net operating income (NOI) for well-managed self-storage facilities in strong markets.
Lack of New Construction
The third leg is the lack of any meaningful new construction of self-storage facilities over the past five years, thus allowing the existing overbuilt capacity created between 2004 and 2008 to be absorbed. This has permitted those overbuilt markets to fill and for storage owners to begin raising rents as demand has grown.
There simply has been no appetite from the lending community to make construction loans for self-storage. As a result, the pipeline of new product is very small, and that doesnt look to change for at least several more years due to the normal construction-permit timeline.
The combination of these three factorsinterest rates, the recovery and lack of new constructionhas caused a bonanza for the self-storage industry, or at least the larger participants that employ current marketing methodology and best practices. This is never more evident than in the share prices of the four public real estate investment trusts (REITs) in the self-storage sector.
However, the good times for the smaller one-off owners and those sites in the smaller secondary and tertiary markets, as well as the rural markets, have generally not participated in the recent industry turnaround. More often than not, their lack of participation in the market uptick has been due to a lack of best-practices management, which is not keeping current with the latest marketing requirements, especially those activities related to the Internet.
Competing for Acquisitions
What is Devon Self Storage doing with respect to the sale of any of its assets, and how are we competing for acquisitions with investors that are willing to pay 6 percent cap rates or lower? During the first six months of 2013, Devon sold two assets. Both sold at the very high end of what we had been anticipating after a rigorous bidding process in the open market, where our broker distributed the properties information to more 4,000 prospective buyers. We saw firsthand whats occurring with stabilized properties in strong markets.
At the present time, we do not have anything else thats likely to be on the market in the coming quarter, but that doesnt mean we wont receive an unsolicited offer for one of our assets at a price that would be difficult to refuse.
On the acquisition front, Devon has a very narrow target for acquisitions. We are proud to be classified as bottom feeders in that were looking to either acquire first mortgages at a significant discount to the face amount on a troubled asset from a troubled lender, or make an equity purchase where the price we can achieve is significantly below replacement cost and, again, we have a very troubled seller with a very unhappy mortgage holder.
We believe Devons superior property and asset-management team can turn around that troubled asset and generate a significant return to our financial partner. That return is typically greatly enhanced due to the very favorable acquisition price, as the real profit on a real estate investment is made at the purchase, not the sale.
Thus, while the public REITs and the huge institutional investors are chasing the few portfolios of class-A or -B properties at what Devon believes to be inflated prices, we will continue to try to find the proverbial needle in a haystack by acquiring significant value-added assets and managing them into a position where we can then sell those assets to those 5 percent cap buyers as we have done twice this year already.
Kenneth E. Nitzberg is chairman and CEO of Devon Self Storage, which owns or manages 32 facilities across the country. The company is based in Emeryville, Calif. For more information, call 800.995.4480; visit www.devonselfstorage.com .
