Private Equity Positioned To Soar Into Storage Sector
Political changes in Washington, D.C., combined with the Federal Reserve Bank’s expectation to raise interest rates in the months ahead, could subject the capital markets to subtle changes or even strong turbulence in 2017.
forces will affect how capital makes its way into self-storage, and, inside the
industry, perhaps nothing will buffet the sector as strongly as the real estate
self-storage REITs had an adventurous ride throughout 2016. The REITs were
aggressively pursuing acquisitions during the first half of the year and, some
experts say, overbidding for prime properties. Then, during the latter part of
2016, it appeared that the publicly traded companies had backed off on buying.
professionals predict the REITs will take an even more measured approach to
acquisitions and other financial undertakings this year. Prior to last year,
the REITs were the darlings of Wall Street, given their decades of steady
performance and reliable returns. But self-storage became an apparent victim of
its own success, raising expectations on Wall Street. Investors can be a fickle
bunch; when performance is lower than their expectations, they are quick to
to be what happened to self-storage REIT stocks in 2016. As a result of the
stock market and other factors, some of the REITs’ plans have been grounded.
open the door for private equity funds, which have largely waited on the
sidelines with millions of dollars to invest in self-storage but haven’t had
the right opportunities to deploy their capital. This could mean a new supply
of capital for the sector, however, without aggressive REIT participation, some
facility owners may be disappointed that their properties don’t measure up to
the same values they saw in the market last year.
looking to refinance, expand, remodel, or acquire new properties, there are
still numerous sources of capital available. “It’s a great market for
self-storage owners,” says Devin Huber, a principal with The BSC Group in
Chicago. “Self-storage is being widely accepted by lenders given its historical
performance through the recession. Lenders can’t get enough storage exposure,
especially on stabilized properties.”
Depending on need and a variety of other factors, self-storage
operators are able to acquire capital from local banks, credit unions, national
lenders, insurance companies, commercial mortgage-backed securities (CMBS), and
Small Business Administration (SBA) loans, as well as private lenders.
According to the 2017 Self-Storage
Almanac, local banks have been the primary source of capital for most
self-storage owners. “Borrowers will often find that local and regional banks
can produce extremely compelling quotes. A local or regional bank is the most
likely lending partner for a developer with a viable project in a high-demand
trade area,” the Almanac reports.
The typical insurance company prefers to lend on high-quality stabilized
assets in core markets, with a focus on experienced, well-capitalized
borrowers. Although life insurance company lenders historically prefer a $5
million loan minimum, increased competition has motivated some companies to
lower this minimum.
SBA loans are made to small business owners by a bank and
partially guaranteed by the SBA. This guarantee minimizes the risks of lending
to borrowers who might not qualify for traditional financing. SBA loans usually
benefit owners in secondary or tertiary markets who may be limited by
traditional financing options.
CMBS lenders have historically been a compelling source of funding
for self-storage owners. CMBS loans are non-recourse debt products that allows
borrowers to achieve leverage up to 75 percent or higher. CMBS lenders prefer
large primary-market deals, but they also compete for loans as low as $1
million in secondary or even tertiary markets.
CMBS lending has proved to be volatile during certain economic
periods, including last year. “Capital market volatility, higher investor yield
expectations, and uncertainty about new regulatory implementation stunted CMBS
volume in the first half of 2016,” the Almanac
reports. Data from Commercial Mortgage Alert shows that U.S. issuance totaled
approximately $51.8 billion as of October, down from $81.6 billion through the
same period in 2015.
Movement in spreads was one of the main reasons why CMBS had such
a rocky start to the year. Another complication involves regulations that went
into effect in December as part of the Dodd-Frank Act, which requires lenders
to hold on to a larger portion of conduit deals. This legislation has caused
some flux in CMBS activity and may continue in the future.
Players In The Game
In additional to these traditional sources of financing, newer
players are starting to enter the self-storage arena. “We are seeing real
estate private equity groups, pension funds, and more recently sovereign wealth
funds and international money trying to get into the space,” Huber says.
A sovereign wealth fund consists of pools of money derived from a
country’s budget and trade surpluses, and from revenue generated from exports.
These funds are set aside for investment purposes to benefit the country’s economy
“There is more private equity money coming in than I’ve seen in
the past,” says Kate Spencer, managing director of Cushman & Wakefield’s Self
Storage Practice. “Returns over the last few years have attracted interest from
a variety of people who are looking to get in.”
In recent years, private equity groups ran up against a REIT in
their bids to acquire prime self-storage properties. An example of this was
last year’s acquisition of LifeStorage by Sovran Self Storage, a Buffalo-based
REIT that changed its name to Life Storage following the purchase of 84 stores
for $1.3 billion. “That’s a good example of a large transaction where there was
a lot of interest from new equity to acquire that portfolio, however, it went
to Sovran,” Huber says.
Another hurdle players outside of the self-storage realm have to
negotiate is the limited amount of choice portfolios available for sale. “When
you have a pension fund, a real estate equity fund, or a sovereign wealth fund
trying to deploy hundreds of millions of dollars, it’s not impossible in
self-storage but it’s extremely difficult to do because there’s just not that
many transactions of that size,” Huber says. “When there are, they have to
compete ferociously with public REITs and well capitalized existing operators.”
Huber adds that many institutional equity sources want to write
checks for $100 million or more, but transactions of that size are relatively
rare in storage. “When you’re talking $200 million-plus portfolios, you can
probably count on one or two hands the number of $200 million-plus portfolios
that traded each of the last several years.”
In addition to the LifeStorage acquisition, 2016 saw large
operators and private equity firms acquire major portfolios:
National Storage Affiliates (NSA),
the newest self-storage REIT based in Glenwood Village, Colo., made a splash in
September when NSA partnered with a pension fund to acquire Winter Haven,
Fla.-based iStorage and its 66-facility portfolio for $630 million.
Harrison Street Real Estate
Capital sold 13 properties for $186 million to Sovran Self Storage (now Life
Storage). The portfolio encompassed assets in New England, Texas, and
California, allowing the REIT an entry into the Los Angeles market.
At year end, Casey Storage
Solutions of Auburn, Mass., sold a portfolio of 13 facilities in four states to
an institutional joint venture for nearly $100 million.
Toronto-based Brookfield Asset
Management and its institutional partners acquired Orlando-based Simply Self
Storage with over 192 operating facilities for $830 million.
Crow Holdings Capital-Real Estate
(CHC), a Dallas-based asset manager of private equity real estate funds,
announced last year it plans to expand its investment activities in the self-storage
sector. By the second quarter of 2016, CHC had acquired or provided joint
venture development equity for 14 self-storage facilities across the U.S.
Another institutional investor,
Prime Group Holdings, has been among the largest buyers of self-storage
properties. Prime Group had planned to invest more than $450 million in
self-storage properties for 2016.
While 2016 was an active $100 million-plus portfolio sale year,
the general consensus in the brokerage community is that fewer large portfolios
will change hands in 2017.
“It will be an active transaction year, just not as many large
portfolios,” says Greg Wells, senior director of Cushman & Wakefield, who
brokered the sale of the Magellan Group in Southern California to Sovran for
$105 million last year.
Equity Takes Flight
For the five
self-storage REITs, 2016 was the best of times and the worst of times. Flush
with cash, the first half of the year was a heady time for deal-making. The
REITs were actively scooping up mega deals while private equity players were
left out of the mix.
mid-year, comfortable tailwinds turned into turbulent headwinds. One of the
issues the REITs contended with during the year was a slowing of net operating
income, which fell to single digit growth compared to double digit growth of
previous years. At another time, this level of return would be acceptable, but
self-storage prior to 2016 stood head and shoulders above other REIT sectors.
the REITs had to contend with new facilities entering the market. The
competition affected lease-up timing and rental rate growth. Also, increasing
interest rates have impacted operations.
As a result,
the storage REITs suffered a deterioration in their stock prices throughout the
year. In fact, a NAREIT index of REIT sectors indicates that self-storage
stocks had the worst investment performance in 2016 with a minus 8.14 percent
return compared to a positive return of 40.65 percent in 2015. The only other
REIT sector showing a negative return for the year was the regional malls
“Self-storage had been in such a year-over-year exponential growth
rate that you saw some profit-taking,” Wells says. “Some of that revenue growth
was driving that stock appreciation, so as that has started to slow, investors
said it’s a good time to sell. Things were on such a hot run for so many years
there needed to be some correction on stock prices.”
Also, the sector’s energetic development rate may be making Wall
Street uneasy. “The REITs’ stock prices were priced to perfection and so any
slowdown in rent growth or same store sales is what’s caused a pullback in the
stock price,” Huber says. “That coupled with the uncertainty of what new demand
is going to do to rental rates and occupancy has Wall Street taking a more
The various headwinds and lower stock prices may be causing the
REITs to be less aggressive in how they price acquisitions. “Toward the end of
the year their underwriting started to be more conservative and they were
pickier with what they were buying,” Wells observes. “That coincides with their
quarterly earnings; they’ve had some quarters that their revenue growth has
slowed from previous quarters, so they started building slower revenue growth
into their model, which makes them potentially a little more conservative in
This could allow more private equity to enter the market. “Before
the summer of 2016, a lot of private equity wanted to get into the storage
market, but they couldn’t compete with the REITs,” says Steve Mellon, managing
director at Jones Lang LaSalle in Houston. “Since the summer, the REITs have
become more selective in their pricing. This is great news for the private
equity world because they can jump in and fill the void of the REITs’
The byproduct of this phenomenon is that some properties are
fetching lower bids than owners were expecting. “The private equity groups are
now able to buy at a price that six months ago the REITs would have just outbid
them,” Mellon notes. “Private equity groups couldn’t get the underwriting to
pencil at the price REITs were offering. If the REITs aren’t going after that
asset, it’s not going to get the same amount of money for the owner as it could
six months ago.”
When private equity firms enter the self-storage space, they sometimes
partner with operators who own multiple properties and want to expand their
operations. The facility owners usually don’t have the capital to purchase the
properties, so the private equity firms provide upwards of millions of dollars
The potential pitfall in this arrangement is for the property that
is targeted for acquisition. “When an owner receives an offer, it is very
important for the seller to understand the equity source behind the operator
that made the letter of intent,” Mellon cautions. “The trend I expect in the
next 12 months is operators placing numerous properties under contract and
closing on the better deals and dropping the contract on others that their
equity partner declines. You’re going to see a lot of deals have false starts.”
In The Wind
While owners of stabilized properties should have few issues
finding funds for their pursuits this year, there are some caution signs ahead.
With the accelerated rate of new development in recent years, construction
financing may become more scarce. “While banks are offering construction loans,
they are doing so with caution, preferring guarantors with strong balance
sheets and significant development experience,” according to the Almanac.
“We have seen a tightening in the capital markets with regard to
self-storage development loans,” Huber says. “We think the tightening is due to
the amount of product coming out of the ground the last couple of years. Many
of the lenders are getting filled up on their construction or development
budget and are taking a wait and see on how deals that we have in the pipeline
perform. Because we’re starting to enter the later part of the development
cycle, we are seeing a measured pullback from lenders in the development
This apparent pullback appears to be concentrated only in certain
markets for now, as some lenders become more selective about advancing funds to
specific markets or sponsors.
“That criteria might mean there is less construction financing,
but I don’t think it’s an industry-wide pullback because there is too much
supply coming in. It’s very trade-area specific,” says Wells.
“I haven’t heard of any of the lenders I work with say they’re no
longer doing any self-storage construction lending,” Spencer adds. “By the time
it gets to us when we’re bidding appraisals, that’s all been vetted, so I’m
still doing plenty of construction loans in Texas and certain markets can
support that. It’s a function of doing due diligence before accepting the
Another possible headwind is the prospect of more interest rate
hikes from the Fed, but self-storage has a reputation for riding out storms
better than other real estate sectors. “As interest rates rise, cap rates have
to follow,” Huber says. “I think self-storage will be somewhat sheltered
because of the amount of new capital still trying to get in. There’s a lot more
demand for storage than there is supply from an investment standpoint, and that
will keep cap rates compressed. As interest rates move up, self-storage cap rates
won’t move up as rapidly as other asset types.”
How will rising interest rates potentially affect the ability to
finance new projects? “If a buyer is debt sensitive and they used to be able to
borrow money at four percent and now it’s 4.5 or five, their cash flow is
directly affected and they will adjust their underwriting accordingly,” Wells
says. “I don’t think a rise in interest rates would slow development financing;
it’s just going to get built into the numbers.”
Spencer echoes that sentiment. “There is still so much demand for
storage product that so long as interest rate increases are on the lower end,
it will likely not have much effect on cap rates because there is so much
David Lucas is a freelance writer based in Phoenix, Arizona, and a frequent contributor to all of MiniCo’s Publications.