Despite the disruption the coronavirus pandemic has created for numerous industries, certain business types still provide opportunities for investors during the recession and are likely to do so well into recovery. Self-storage is one of the most resilient asset classes in the market, in part because the number of people using storage continues to climb, and the unique fundamentals of operating the business make it attractive.
We’re beginning to gain clarity on how much the self-storage industry has been impacted by the health crisis and subsequent recession. Below is what we’re seeing across the sector today.
Operating Performance
While self-storage isn’t immune to pandemic impact, it is adjusting. Before COVID-19 and the economic downturn, the industry was trending upward. The glut of new construction in the U.S. had hit a peak, and the development cycle reached a plateau midway through 2019. At the end of the first quarter of this year, absorption of new supply increased demand, leading to upward trends in rental rates and occupancies.
During the pandemic, some operating metrics have declined, though occupancies are still high at stabilized facilities. Rental income initially took a hit but is recovering. Move-ins and move-outs have declined compared to 2019, but this is partially due to local regulations put in place to halt foreclosures, delinquencies and late payments.
Rental rates have been impacted because of two main factors, the first being discounted rates on move-ins. To keep occupancy high and maintain income lost from move-outs, the real estate investment trusts (REITs) were forced to lower rates for new customers. The early months also forced REITs and other operators to halt rate increases on existing tenants. As of September, many of the REITs had resumed rate increases, but the hikes weren’t as aggressive as they would’ve been under pre-pandemic conditions.
Though self-storage street rates have declined compared to 2019, there was positive, month-over-month growth from July to August, according to self-storage data-services platform Yardi Matrix. After rates dropped at the beginning of the pandemic, the market is stabilizing. As perceptions of the economy and the market as a whole continue to shift, we expect opinions regarding capital gains and subsequent structure to do the same.
Self-storage occupancy levels have remained relatively consistent this year due to lower than normal move-in and move-out activity. There’s been some increase in demand driven by rate decreases. On the flip side, there have been move-outs of tenants that might, under normal circumstances, have gone to lien sale.
Development Activity
Before the pandemic, development drove self-storage supply to an all-time high, and new deliveries were putting downward pressure on rental rates in almost every major market. The development cycle peaked in 2019 and was in a state of plateau. As a result of market uncertainty, financing dried up and pro forma assumptions were adjusted, causing many developments to pause or be abandoned altogether. During an earnings call, Public Storage Inc. CEO Joseph Russell indicated the slowdown “would be a welcome relief, particularly in the markets that we've been pointing to over the last couple of years that have been hit heavy with new supply.”
Yardi Matrix expects deliveries to fall roughly 10 percent in 2020 and about 40 percent over the next five years as short-term construction delays and long-term financing and permitting issues slow development. Facilities under construction will be seen through inception, but three- to six-month delays should be expected. The shutdown of construction sites will increase timelines, and materials are more difficult to source.
Acquisition Activity
Self-storage acquisitions are still progressing and are expected to possibly increase further. During the second quarter, the five largest REITs acquired a total of 13 new assets. They reported in their earnings statements that, despite the pandemic, they were still interested in growing their portfolios through acquisitions and development.
Fully occupied facilities with positive cash flow continue to be the most attractive deals, while Certificate of Occupancy and lease-up facilities have also been of interest. While they’re less attractive compared to stable deals, there’s still some demand for these facilities, especially in supply-constrained locations or submarkets with strong demographics and long-term viability.
Moving Forward
Self-storage is a resilient asset class that has proven it can bounce back during hard times. Rental-rate compression will continue until supply has stabilized. While new construction has slowed, it certainly hasn’t halted. Investors should pay close attention to new deliveries in their markets, and developers should be cautious in proceeding with new projects in areas that have robust supply.
Overall, real estate sectors like self-storage that have healthy demographic and structural drivers will recover more rapidly while others face challenges. According to our chief economist, Kevin Thorpe, the new economy will need new things. “So, whether we see converted or reimagined malls, hotels, movie theaters, obsolete office buildings, fitness centers or more, investors and users will find opportunity to reinvent real estate.”
Luke Elliott is executive managing director, Mike Mele is vice chairman, and Steven Paul is a financial analyst with the Self-Storage Group of Cushman & Wakefield. Founded in 1917, the company offers a complete range of services for all property types including consulting and appraisal, corporate services, debt and equity financing, investment banking, leasing, and sales and acquisitions. For more information, visit www.cushmanwakefield.com.
