The last few years have been an extraordinary time for the self-storage business, and real estate experts agree now is a good time to buy, sell or refinance. Sounds good all the way around, right? Todays low interest rates and strong fundamentals have made good deals even better, and the cash-on-cash returns are simply staggering for owners, buyers and sellers. Self-storage has truly become a respected, maturing competitor in the national real estate market.
Weve all seen the comparison of the self-storage industry to other real estate sectors in recent years and, in short, the returns for self-storage are higher and the various risks are more moderate with one exception: the risk of overbuilding. The main reason is self-storage properties are all competing for the same customer, and were a more localized business than other real estate sectors.
The office, retail and industrial sectors can target specific customers, businesses, professionals and industries, such as medical-office buildings, research and development industrial complexes, and destination retail. It has been proven that the customers of these real estate products will travel great distances. Conversely, all self-storage customers are basically looking for the same producta friendly, clean, safe and dry place to store their personal treasures. In almost every case where occupancies and rents have declined, theres strong evidence that overbuilding is a substantial contributor to this undesirable market condition.
When it comes to overbuilding, nobody wants to do it. While some builders claim the devil made me do it, most really dont want to develop a poorly performing project. So why do they proceed? While a few are just stubborn beyond any rational considerations, most are thoughtful and concerned about how they invest their money. Thus, when they investigate an opportunity to develop in a specific market, they seek the best information to justify their decision.
The problem is most self-storage information is either unavailable or unreliable. Most other real estate industries (i.e., office, hotels, industrial, retail) have well-developed and reliable information on the state of their markets. For example, in any city in America, an office developer can learn the average rents, concessions, planned projects and occupancies by building quality and submarket in about a half a day. This information is largely developed by empirical data (actual data) as opposed to statistically developed data (small amounts of surveyed data projected to a much larger conclusion).
Every other major real estate sector has information based on substantial, comprehensive empirical data. Unfortunately, the bulk of information in the self-storage industry is still statistically developed.
For the most part, self-storage professionals have to rely on statistical projections which, at best, provide limited information about the largest markets and none about submarkets or secondary markets. Information about submarkets is the most valuable for owners and developers. The lack of quality submarket information leaves most developers flying blind when making the decision to build a self-storage project. Some may say it's a great site, but they should also ask if it's a good market.
For many complex reasons, including the availability of construction money, entrepreneurial developers are rarely scared off by this lack of information; in some cases, they actually seem to be encouraged by it. However, many of the very large self-storage operators seem to have a good handle on whats going on in a specific market and are developing and buying properties with the significant strategic advantage of having empirical (actual) data. Without access to this type of information, the entrepreneurial developer doesnt have the ability to make the right decision and might potentially build a project that could ruin an entire market for a long time.
Dangers of Overbuilding
All over the country, we see building and development cranking up in every place where zoning can be achieved, although nowhere near the levels of the early to mid 90s. Construction loans no longer appear to be a constraint on building. So let me describe a hypothetical market and show you what can happen to a good market when the tipping point of demand has been reached.
Our hypothetical market, summarized in the table below, includes five properties of 50,000 square feet each and an average occupancy of 88 percent. This means theres a supply of 250,000 square feet in the market and an actual demand of 220,000 square feet. A new developer decides to build an 85,000-square-foot facility. Supply is now up to 335,000 square feet, but demand is still at 220,000 square feet, bringing the market occupancy down to 65.7 percent. The new developer didnt bring any new tenants to the market.
Now, if we have indeed hit equilibrium in this market and demand is no longer exponential, we can assume demand will just grow with the population. The U.S. population growth rate is 0.71 percent per year, according to Worldbank.org. As you can imagine, we have a fairly serious problem on our hands, as this market will take years to achieve the 88 percent occupancy it once enjoyed.
Investment Protection
Its clear the development train is back and rolling down the tracks, but to protect your investment and the integrity of the industry, we must take the necessary steps to generate high-quality, reliable information, allowing and encouraging better building decisions. I would encourage independent owners to participate in the following:
- Resolve to help by agreeing to provide information on your project to an independent industry-sanctioned collector of information who can tabulate the data without giving away your secrets.
- Vigorously encourage your state association as well as the national association to create an effective plan to develop this information and be willing to participate.
- Conduct an independent survey of your local submarket, one each operator can share. Make sure your local planning department gets a copy and thats updated regularly.
- Potential developers must get a real and critical feasibility study, including a detailed supply-and-demand analysis. Its an empirical process and not one that can be done by the smell test.
If, indeed, the tipping point has been reached in an area or market, owners in those markets are in for some more extraordinary times. We can only hope that current owners and potential developers have learned lessons from the last development boom and will approach their decisions in an educated and cautious way. If you have any questions or doubts about how your market is poised to absorb potential development, it may be time to review your building plans and holding decisions.
Ben Vestal is president of the Argus Self Storage Sales Network, a national network of real estate brokers who specialize in self-storage. Argus provides brokerage, consulting and marketing services to self-storage buyers and sellers and operates SelfStorage.com, a marketing medium and information resource for facility owners. For more information, call 800.55.STORE; e-mail [email protected]; visit www.argus-selfstorage.com .
