Proceed With Caution in Secondary Market Self-Storage
The multifamily market activity in Western US secondary markets, like Las Vegas and Phoenix, has sparked self-storage market growth—but it could be outpacing demand.
“Storage demand in those markets continues to be steady and continued multifamily construction will only help to maintain that demand,” Charles Byerly, president and CEO of US Storage Centers, tells GlobeSt.com. “However, these markets are generally the last few markets to recover from a downturn, which has certainly been the case this go around as well. We are seeing significant storage development in the greater Phoenix market already, so that market will have issues over the next few years.”
While Phoenix may be heading toward supply issues, Las Vegas and the Inland Empire might fair better. Self-storage construction is rising, but land and construction costs have helped to temper activity. “Las Vegas has started to see development in several of its sub-markets, but with construction costs, land costs and rising interest rates, we would hope that development doesn’t go overboard in Las Vegas,” he says. “The inland empire continues to have would-be developers look into sites that are zoned self-storage, but if the developer is being honest with their rental rate and leasing absorption assumptions, those sites do not pencil. Unfortunately, as with every cycle, developers don’t always use realistic assumptions because the deal won’t get done.”
Still, the firm is still looking for opportunities in the market, particularly in areas where construction activity has been moderate. “Unfortunately, those are far and few between,” says Byerly. “Phoenix is cooked, and we would find it hard to invest in that market today. Las Vegas has some bright areas for acquisition for older product that can use a material amount of cap-ex and a better operating platform. We would not develop in Las Vegas today.”
The Inland Empire might have the best opportunity for self-storage investment, but the market is bifurcated. “The Inland Empire is a tale of two stories,” adds Byerly. “The foothill markets and riverside area continue to be steady, but as you get into San Bernardino, highlands and the lower desert areas, it is much less desirable. We would not develop in the inland empire market today. So I would say if you can find the needles in the haystack that have been grossly mismanaged and you can enter at a palatable current yield, that is the one bright area in these markets.”
While US Storage Centers is cautious, there is a significant amount of capital chasing deals in the market, both from existing players and new entries into the market with substantial capital. This could be a potential issue for the self-storage market. “It is the latter that is much more successful getting deals done today,” says Byerly. “My suspicion is that their underwriting assumptions are way too aggressive so they have put a substantial amount of capital to work in these and other markets and won’t know how much they are really off for a couple of years. This may point to where we are in the cycle as well: Lots of capital, and very few deals that work.”
At this point, cap rates in secondary markets have compressed to match primary markets, like Los Angeles and Orange county. Byerly says that this is also reflective of where we are in the cycle. “We’re at the point in the cycle that has really closed the gap in primary and larger secondary markets in terms of the difference in cap rate and desired return on existing self storage facilities,” he says. “The lines are certainly blurred. Since there is so much capital chasing deals, would-be-buyers are pushing the pedal hard in both primary and secondary markets to get deals across the finish line. This is evident in the development side as well. Would-be developers are really combing all markets right now to add product and like I said above, I don’t believe phoenix, Las Vegas or the Inland Empire are markets that can take much more product.”