Reality Sets in for the Self Storage Sector

Self storage developers pulled back on construction in the first half of 2023, allowing time for the additional supply to be absorbed, according to an H1 2023 Self Storage Report from Cushman & Wakefield.

Meanwhile, occupancy was stable at 90% in Q4 last year and remained flat for the first six months of 2023.

“Current construction levels represent 0.3% of the existing supply, which is more in line with longer-term construction trends,” according to the report.

Its valuations remain intact (averaging $165 per square foot) representing a 2.5% increase YoY. That is down slightly from the 2022 peak.

Transaction volume subsided significantly in the first half of 2023 with the trailing 12-month volume down by 57% year-over-year (YoY).

Headwinds will come the rest of 2023 through the increased cost of debt and lack of overall liquidity, resulting in opportunities for well-capitalized investors.

Nonetheless, self storage remains a top performer, according to the report.

Tom Dao, Principal, Gantry, tells GlobeSt.com that at the recent Self Storage Association Fall 2023 conference, there was a generally optimistic but decidedly more realistic industry pulse.

“Uncertainties are emerging, however, beginning with operating expenses, mainly property taxes and insurance,” he said.

“This is putting stress on net operating income. The pace of rental rate increases has cooled, and some regions are seeing rate decreases. That is new after an industry-wide banner year for rents and growth in 2022.

“Insurance company lenders are very active in self storage with conservative underwriting to provide the most competitive rate and term, non- recourse financing; with the loan amount typically constrained by cash flow. 

“Banks are still lending if the borrower is willing to put up recourse and move a deposit balance to the lender, from 10% to 30% of the loan amount. CMBS execution is available, but due to rate volatility and underwriting complexities it is often sought after as a last resort.”

Michael J. Romer, Esq., Co-Managing Partner, Romer Debbas, tells GlobeSt.com that although the asset class remains attractive, “the mad rush to acquire self storage facilities appears to have ended. With rising interest rates and acquisition costs, the self storage facility market seems to have stabilized. However, valuations remain strong and overall interest in the asset class is still strong.”

Contrarily, Charles Byerly, CEO of Westport Properties, tells GlobeSt.com that reality has set in for the self storage sector.

“Asking rates have trended down since the middle of 2022 and occupancies have also continued to level off and even fall in most markets,” Byerly said.

“Concessions and discounts continue to increase as well putting a lot of pressure on stores in early lease up that haven’t stabilized. 

“Due to capital market issues, lending has become very difficult putting pressure on would-be buyers and builders of self storage.”

As a result, he said cap rates are slowly rising for all types of self storage, with perhaps the exception of a few trophy properties. 

“Transaction volume is off significantly and fundamentals have weakened, including demand as a result in the residential transaction market. Mobility, which includes home sales, makes up a material piece of self storage demand. The near term will remain challenging likely through 2024.”

Drew Dolan, DXD Capital Principal and Fund Manager, tells GlobeSt.com said asking rates cooled since their peak, “but we are starting this next real estate cycle with asking rates above the previous cycle’s peak in 2016,” he said. 

“In 2023, the lack of availability and cost of debt have impacted both self-storage development and acquisitions just as it has other asset classes. If this trend continues into 2024, new construction starts, and acquisition volumes are expected to be muted through 2025.”

On a nationwide basis, this will delay the overbuilding of new self storage developments and reset the price of acquisitions for existing facilities from their peak in 2022. 

In Arizona, Samuel Rutledge, Sales & Leasing Agent, Commercial Properties, Inc./CORFAC International, tells GlobeSt.com that despite a decrease in transaction volume in the overall real estate market, the self-storage sector in Arizona is anticipated to experience growth, driven by the state’s expectation to outpace other markets in terms of urban growth. 

“Rising urban populations, coupled with a demand for storage solutions in smaller living spaces, along with ongoing technological and sustainability advancements, make self-storage an attractive and resilient investment opportunity.”

Brian Somoza, Senior Managing Director, JLL Capital Markets, tells GlobeSt.com that the recent pullback in fundamentals is more of a reversion to historical norms than a true pullback. 

“There has been softening in asking rents, but we’re not seeing distress,” Somoza said. “2023 has continued to see healthy YoY revenue growth over a record high 2022 comp. This growth is coming from the tried-and-true ECRI (Existing Customer Rate Increases) model that has long been the driver of operational success for storage.”

Michael Plumb, Principal, Lee & Associates of Illinois, tells GlobeSt.com that the self-storage sector represents a tremendous opportunity for the conversion of functionally obsolete industrial buildings, particularly those that are well located. 

“In the greater Chicagoland area, we’ve seen numerous infill conversions of dilapidated industrial buildings. Typically, conversions include selective interior demolition to allow adequate space for modular self-storage units and installation of exterior glass to emphasize the visibility of those prefab units. While it is expensive to do so, raising a roof may also be necessary—but conversion can still cost half of what a ground-up development might.”