The first month of 2008 was beset with significant financial and political "rock-n-roll." If you are like me, much of it doesnt seem to fit into a neat package and signifies what the rest of the year will bring. However, if you will indulge me, I will give you two thoughts on the self-storage real estate market that will hopefully provide some perspective for you to ponder.
The Credit Crunch
The sub-prime residential loan debacle has caused problems in the commercial real estate world as well. It was clear the commercial underwriting standards (how lenders value properties and how much they lend) were quite loose by most historic patterns in late 2006 and early 2007. It was a great time to get a real estate loan, as rates were low and loan proceeds were high.
In late 2007, the rating agencies began to tighten underwriting. The largest source of funds for commercial mortgages came from Wall Street firms, which created commercial mortgage backed securities (CMBS) loans that were repackaged and sold to investors. In late summer 2007, loan underwriters decided commercial loans were too generous in terms of loan proceeds and values were overestimated.
Sound familiar? At present, the problem is not nearly as serious as the residential situation, but no one is certain what will happen if the credit crisis becomes worse. This situation has also affected values of commercial real estate as cap rates have generally increased by about 1 percent (from 7 percent to 8 percent, depending on locales).
With the change in underwriting trends and the general concern about mortgage-backed securities, the CMBS market for funds has now become dramatically less available to real estate borrowers. Life insurance companies and many banks have stayed in the lending game for commercial properties, but they are being very conservative about valuations, projections and loan amounts.
The good news is loan interest rates havent changed much since the "good old days" of early 2007. This is because a lot of money has been invested for safety reasons in U.S. Treasury securities and the Fed is lowering the discount rate driving down rates on the benchmark 10-year Treasury bond. The dark side of the situation is that the risk spreads (the amount that lenders add on to the T-bill rate to get the loan interest rate) have gone up dramatically. Over the last year, spreads have gone from about 1.2 percent to about 3 percent at the time this article was written.
My take-home message from this: If there is evidence of potential inflation, the 10-year Treasury rate will rise and, if there is a liquidity problem in the credit markets, the spreads will also increase. What this means for you is that while loan rates are still lowby any historic measure (say 6.5 percent)it might be a very good time to lock in financing for the long haul. These times appear to be very volatile and the future cost and availability of financing may be quite uncertain. Plus, you might sleep better with a loan locked in for 10 years!
The Market for Facilities
The uncertainly in the economy has also impacted the marketability of self-storage facilities. However, unlike the changes in finance availability, the changes have been more moderate and rational. Prices of facilities (per dollar of net operating income) hit absolute all-time highs in about mid-2007. Buyers would accept the validity of just about any projection and would finance the project to the maximum allowed.
The early 2008 market has seemed to find equilibrium at a level that is about 5 to 10 percent below the historic highs. The reality is many sales at higher values were made by investors with OPM (other peoples money), which may have meant they were not as discriminating as someone with experience in the business might have been. However, since the majority of self-storage projects are bought by current owners, the fact that prices have seemed to stabilize is a good sign that serious, experienced buyers recognize good value at the slightly lower prices.
The current market equilibrium may not prove to be very durable for the longer term for several reasons. For example, if the financing market becomes either less liquid or more expensive, the prices for a facility will fall. The math is simple: If you pay the lender more, you cannot pay the seller more, and if you put in a larger investment, you need a larger return.
Additionally, the current concern about a possible recession could cause potential buyers to be more concerned about future revenues. A 10 percent decline in revenue equates to a drop in value (at an 8 cap rate) of about 15 percent; if the property is leveraged at 75 percent of value, the equity would drop about 60 percent.
Clearly, any of these events could have a material impact on an owners investment if the investment horizon is short term, say less than three years. Thus, if you are planning to sell sometime in the not-too-distant future, you may want to give some thought to accelerating the process and putting your equity into T-bills.
Michael L. McCune is president of the Argus Self Storage Sales Network, a self-storage real estate brokerage and development company based in Denver. Argus also operates www.selfstorage.com, a marketing medium for owners in the self-storage industry. For more information, call 800.55.STOR.
