As we look back over the last 10 years, its encouraging to see cautious optimism present in todays real estate market. Self-storage owners have seen their values begin to rebound, and buyers today are disciplined and patient as they seek opportunities that fit their criteria. The availability of self-storage properties appears to be due primarily to owners life events, as very few owners are making the decision to sell, instead wanting to capitalize on the improving market.
U.S. commercial real estate prices climbed 1.3 percent in October 2010 from the previous month, according to the Moodys/REAL Commercial Property Price Index (CPPI). Thats encouraging for a market that has dealt with deflated property values for nearly three years. However, many experts debate whether the recent gains will last.
This improvement in values is small in relation to the overall 42.7 percent value decline the index has tracked since the market peaked in October 2007. In a year of index volatility, the CPPI logged six positive monthly gains and four monthly declines through the first 10 months of 2010. This leaves us with an aggregate gain of just 0.21 percent through October from the year prior. One may argue that the real estate market hasnt fared much better. (The latest update to the CPPI was published by Moody's on Dec. 20 and computed through October 2010. See the accompanying graph.)
Booms and Busts
As we look back on 2000-2010, we can recall experiencing two major booms and busts in the commercial real estate market. Who can forget the dot-com boom that came to an end around 2001-2002? We saw 20-somethings become millionaires overnight followed by the harsh reality that all good things must come to an end, including increasing real estate values.
Most recently, the real estate boom of 2004-2007 was the most prosperous time in commercial real estate history in terms of total transaction dollar volume. During the explosion, we saw savvy investors buying up anything they could get their hands on, with apparently no limit on what they were willing to pay. Interest rates were at rock-bottom historic lows, and there were herds of lenders willing to make very generous loans. This leads me to wonder what the next decade will hold and what factors will play a role in the next commercial real estate boomand inevitably, the next real estate bust.
Government Effect
As we have now entered a new congressional session, we clearly have a political problem that will affect the ability of investors to make rational decisions and maximize their return on investment. In 2010, for example, we saw many owners trying to sell and take advantage of the historically low capital-gains tax rate that has now been extended for an additional two years. This is just one example of several such uncertainties that may affect investment decisions moving forward.
While the power struggle in Washington may have led to a temporarily prosperous time for investors, we must remember that one stroke of the pen can change everything. This, along with the unsettling vibes that are coming from several industrialized countries such as China, Great Britain, Greece and Spain should concern us all. It is my worry that in todays globalized economy, countries like these may not take the necessary steps to head off financial disaster or report the issue honestly. This could have a tremendous trickle-down effect on the U.S. investment climate.
At the beginning of 2011, the 10- year T-Bill was bouncing between 2.5 percent and 3.4 percent, and it appears to be on the rise of late. The accompanying chart shows that over the last five to 10 years, interest rates have been very low when compared to historical rates over the last 40 years.
As a result, low rates have helped real estate investors capitalize on the booms and weather the downturns over the last decade. It is a concern that todays interest rates are being kept artificially low by the fiscal policy being implemented by the Federal Reserve. If we were to see an increase in interest rates in the near term, we may experience a premature commercial real estate bust.
I believe we are experiencing a strengthening in the commercial real estate sector, and the fundamentals of self-storage seem to be following suit. Make no bones about it, if we enter into inflationary times, we will most likely see increasing interest rates that will have a major effect on the investment climate for self-storage properties. We would all welcome some controlled inflation, but as we have seen lately, controlling a globalized economy is difficult.
The biggest fear in the market today is that we will see hyperinflation, particularly as the ability to reverse courses is more difficult today than ever before. Contrary to popular belief, aggressively rising interest rates and highly inflationary times do not necessarily mean higher values.
Capitalize on Improvements
Its important to realize that when youre selling real estate, youre actually selling the income stream that is valued using a cap rate, which is the inverse of interest rates. This means higher interest rates do not equate to higher values. As a result, you may want to re-evaluate your investment strategy in 2011.
Self-storage owners have the unique opportunity to capitalize on the recently improving real estate investment market, as values today are at the high end of historical averages. This will also allow you to avoid the fear of hyperinflation and whatever political problems this global economy may dish out.
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. For more information, call 800.55.STORE; e-mail [email protected].