Despite a contraction in self-storage development activity, declining discretionary incomes and the soft, single-family housing market will continue to weigh on self-storage demand. Occupancy levels at self-storage properties are trending lower as job losses and falling home values encourage households to save more and avoid unnecessary expenditures.
In an attempt to mitigate occupancy decreases, owners have cut rents, causing revenue to decline. Newer assets built during the market peak in once high-growth areas are suffering the most from weak demand, with some markets operating at occupancy levels of 100 basis points below the national average (the low 70 percent range).
Additionally, it may take two or more quarters to determine whether aggressive leasing incentives and rent reductions will be enough to jumpstart tenant demand. Properties in close-in commercial and residential areas are expected to perform better in the short term. When the recovery gets under way, centrally located assets near established neighborhoods will likely benefit from more stable housing conditions and small businesses seeking additional space for expansion.
Development Decline in West to Offset Weaker Demand
Approximately 1.9 million square feet of new self-storage space will be added in the West this year, down from 4.4 million square feet in 2008. More conservative capital markets and soft operating conditions will restrain construction activity through 2010.
The planning pipeline contains 7.4 million square feet, a decrease from 12 million square feet just six months ago. The decline in development activity may help offset weaker demand. Additional inventory and a drop in housing-related self-storage demand have caused occupancy to trend lower during the past year.
As of the second quarter 2009, regional occupancy of 83.1 percent was down 490 basis points year-to-date, and down 680 basis points from the rate recorded in the second quarter of 2008. In response to declining occupancy levels, owners have trimmed rents by almost 2 percent since December 2008 to $1.14 per square foot. Significant construction activity over the last few years and a weak housing market have pushed occupancy in the Inland Empire of California to the low 70 percent range, the lowest rate in the region.
Investment activity remains limited due to a tighter lending environment and expectations for weaker operations in the near term. Transaction velocity has dropped 37 percent during the past 12 months, though it has plummeted 62 percent over the last two quarters when compared to the same period in 2008.
In the past year, properties have sold at a median price of $71 per square foot, a decrease of 4 percent. Cap rates average between the high 7 percent to mid 8 percent range for higher-quality assets, up about 75 basis points year over year, and will continue to increase due to soft economic conditions.
South-Central Transaction Velocity Remains Relatively Stable
In 2009, approximately 580,000 square feet of self-storage space came online in the south-central region, down from the delivery of 830,000 square feet in 2008. About 280,000 square feet was added in the Houston metro area, which has fared better than most markets during the recession due to the presence of companies tied to energy-related firms. The planning pipeline for the south-central region contains roughly 1.4 million square feet, compared with 1.8 million square feet in early 2009.
The average rent for self-storage space is $0.72 per square foot, unchanged over the last year. Occupancy levels, meanwhile, have declined steadily since the second quarter of 2008, despite limited new inventory. As of the second quarter 2009, the average occupancy rate was 85.2 percent, down 380 basis points year over year and 330 basis points lower than year-end 2008.
The New Orleans metro has recorded the greatest loss in occupancy, falling 1,000 basis points during the past 12 months to the high 70 percent range. The drop is the result of economic challenges and weak residential-related demand.
Transaction velocity has slowed approximately 10 percent over the last year, though activity remained steady during the first half of 2009. Despite more consistent market velocity, prices have fallen 36 percent year over year to $37 per square foot. Cap rates have pushed up about 100 basis points in that time, in the low 9 percent range, and will continue to rise over the next 12 months due to expectations for softer market conditions.
Southeast Occupancy Rates Drop
The Southeast was expected to receive approximately 2.3 million square feet of new self-storage inventory in 2009, compared with 2.4 million square feet in 2008. Nearly one-third of the space was added in the Charlotte, N.C., metro area, which currently has more space per capita than the national average. Vacancy will continue to trend higher in the metro over the next 12 months as the new space is absorbed.
The regional planning pipeline contains 2.9 million square feet of self-storage product, down from 5.3 million square feet at the beginning of 2009. Ongoing additions to inventory and a decline in demand related to the recession have pushed occupancy lower. As of the second quarter, regional occupancy was 81.9 percent, a decline of 580 basis points from one year earlier.
Asking rents, meanwhile, were $0.84 per square foot, down 2.6 percent during the same stretch. The Florida markets have recorded the greatest losses in occupancy, driven by troubled housing markets and job cuts. In Jacksonville, occupancy fell from the high 80 percent range in the second quarter of last year to the low 70 percent range in the second quarter of 2009, while asking rents declined by 8.3 percent, the largest decrease in the region.
Investment activity slowed by 42 percent over the last 12 months, compared with an acceleration of about 50 percent in the previous year. Concerns over the housing market and its impact on the local economies have caused investors to limit acquisition activity and seek price discounts.
The median price has declined 29 percent to $45 per square foot during the past 12 months. Cap rates in the region have averaged in the mid to high 8 percent range in the last year, although yields in some recent transactions have been in the 9 percent range.
Moving into 2010, transaction velocity will likely stay constrained through the first half of the year, as investors continue to take a wait-and-see approach to the near-term direction of the market.
Investment activity will center on smaller, stabilized assets in strong locations nationwide. Properties under $3 million that have positive cash flow and local financing available will garner the most interest. Cap rates, though difficult to discern due to limited activity, average in the 8 percent range for class-A properties, while class-B properties are trading at 9 percent and above.
Initial yields in both classes are up about 25 basis points to 50 over the last six months. Cap rates will continue to rise in 2010 as buyers underwrite for higher vacancy rates and increased concessions.
Rents Expected to Decline in the Northeast
Developers were expected to add about 625,000 square feet of new self-storage space to the Northeast in 2009, down from 1.5 million square feet in 2008. Over the past five years, completions have averaged 1.5 million square feet annually. Three projects were brought online in Brooklyn, N.Y., totaling about 160,000 square feet. The planning pipeline for the Northeast contains approximately 2.2 million square feet, a decrease from 5.3 million square feet six months ago.
Despite a significant decline in new inventory, waning demand related to job losses, along with a weaker single-family housing market, eased regional occupancy to 86 percent in the second quarter. The Buffalo, N.Y., metro area currently has the lowest occupancy rate in the region in the high 60 percent range, while Providence, R.I., has the highest occupancy rate, in the high 80 percent range.
The average asking rent in the Northeast is $1.04 per square foot, down 1.6 percent year over year. Soft housing and employment-generated demand will further drive down rents through year end.
Transaction velocity has declined 29 percent over the past year, with the median price falling 5.9 percent to $64 per square foot, as of the third quarter.
Additional price drops are expected as buyers underwrite deals for greater use of concessions and lower occupancy levels. Cap rates currently average in the high-8 percent to low-9 percent range, up about 50 basis points from one year ago, and will continue to tick higher due to investors’ expectations for increased near-term risk.
Greg Wendelken is the national director of the National Self-Storage Group of Marcus & Millichap Real Estate Investment Services in Seattle. To reach him, call 206.826.5700; e-mail [email protected].
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