You may have heard that now is a good time to buy, develop, refinance or sell self-storage properties. Sounds good all the way around, right? The strong market fundamentals and liquid lending market have made good deals even better, and the cash-on-cash returns are simply staggering for buyers, owners and sellers alike. We’ve all seen the comparison of self-storage to other real estate sectors over the last few years; in short, the returns are higher and the various risks more moderate in our industry—with the one exception: overbuilding.
The general market fundamentals are compelling for new self-storage development around the county. However, as you dig into each potential site, make sure there aren’t several other projects coming online in your market, as new storage projects appear to be clustered in areas with similar demographics.
Overbuilding is a critical issue facing our industry, as developers are loading the pipeline with product that will hit the market over the next 12 to 36 months. This article will help you recognize the potential consequences of overbuilding in your market and provide steps you can take to protect your business.
What Is Overbuilding?
Let’s begin by defining what I mean by “overbuilding.” This is a market condition in which self-storage supply exceeds demand (renters) at any given time. I suggest that almost all markets are overbuilt to some degree if there’s more than a nominal vacancy there.
For example, a stabilized market that averages 88 percent occupancy might really be overbuilt by 12 percent. While 88 percent isn’t economically life-threating, it indicates excess demand simply isn’t there; otherwise operators would be renting more units.
Self-Storage Demand
What do we know about self-storage demand? The quick answer is “not much.” The overall issue is complex, and results are inconclusive at best; but several bright industry groups have moved the information in the right direction.
During the first 30 years of the industry (1970 to 2000), no one worried about demand because there was so much pent-up need for our product. However, over the last 15 years, we’ve learned that demand is elastic and mainly driven by population growth and income levels. Thus, we can be reasonably certain that if demand is to increase, there has to be more people and, hopefully, those with higher income levels.
Self-Storage Supply
What do we know about supply? The first thing we know about a lot of new projects is they’re driven by the high returns the industry has produced over the last several years and the availability of cheap money more so than the careful analysis of demand. There’s plenty of money available for a credit-worthy builder if someone will give him a positive feasibility study. We’re estimating 250 to 350 new projects will open in 2015, and that number will nearly double in 2016. It could be very scary in 2017 if the majority of the projects on the drawing board get built.
By our best estimation, the U.S. storage industry can typically absorb 400 to 500 new projects each year if they’re appropriately spread throughout the county. The problem is they all seem to be built in the areas with the highest rents, and most builders who can get financing are all focusing on the same core markets. The new projects aren’t being appropriately dispersed.
The Impact of Overbuilding
The table below shows the impact of one new facility in a hypothetical market with an 88 percent occupancy level. Study it closely because, over time, the existing occupancy will roll over and level out among all competitors, depending on their competitive merits. If the new facility has “a better mouse trap,” more marketing, lower rents, etc., it might actually get a larger (perhaps much larger) share of the market. Remember, the new facility doesn’t create demand; it can only steal it from someone else!
Assuming the pent-up demand from the last five years is nearly exhausted, how long would it take for this market to grow out of its problem? Assuming there are unlimited opportunities for growth and no more new competitors, the demand has to grow by 25 percent to get back to the average 88 percent occupancy.
The United States experienced a population growth rate of 0.8 percent last year, and the fastest growing city expanded 6.5 percent. Dividing the occupancy deficit by the annual growth rates shows that it takes 21 years for the market to return to 88 percent occupancy, and the absolute best-case scenario is 2.7 years. The economic effect can also be troublesome, as self-storage owners typically find themselves in a rental-rate war when competing for occupancy with a new project.
Each market is different and requires unique projections, so my rough calculations should only be used to get a perspective on the potential magnitude of the consequences of overbuilding. Even with major adjustments, the problem can be very serious and affect storage owners significantly.
Overbuilding doesn’t have to be a citywide or nationwide phenomenon; it can affect just one small market. A careful analysis of your market is in order to see where your facility stands. It’s always good to stay in touch with your local planning department to know what may be built around the corner.
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.
