As a mortgage broker specializing in self-storage, my typical week
includes speaking with dozens of operators, developers, investors, and lenders.
Over the last three years, these conversations generally share a common theme: construction.
It’s well documented that the storage industry is experiencing an unprecedented
expansion cycle. Based on data published by the U.S. Census Bureau, it is reported
that $3.05 billion has already been spent to develop and construct storage
through the first seven months of 2018. This compares to $1.22 billion in all
of 2007, $366 million in 2012, and $3.95 billion in 2017. Discussions at
industry trade shows often circle around new supply recently delivered or
forthcoming and subsequent effects on rental rates and occupancy. Despite
cautious conversations on the trade show floor, panel discussions highlighting oversupply,
and articles about depressed rents, it hasn’t slowed the weekly calls from people
looking to finance their latest and greatest storage development. Most people don’t
want to hear that it’s not prudent to build across from a new 150,000-square-foot,
state-of-the-art facility. If the trade show chatter, warnings from industry
leaders, and data provider presentations aren’t enough to scare people away,
what will curb the fierce pace of construction and ultimately save us from a
deep downturn? The answer is the lending community.
The capital markets came to a halt after the Great Recession. In
2011 to 2012, we started seeing loans made on stabilized facilities. It wasn’t
until 2013 to 2014 that the window for construction financing started to crack
open. In 2015 to 2016, construction financing was readily available for quality
projects with strong sponsors. We saw a shift in 2017 as lenders began asking
tougher questions; they cared about new supply, questioned if the rapid lease-up
velocity experienced during this cycle could be sustained and, frankly, many
lenders were “filling up” on their desired exposure to storage development. In
short, it became harder and harder to obtain construction financing for storage.
Fast forward to today; we deem most development deals that cross our
desk as unfinanceable. While there are still lenders making storage construction
loans, they are highly selective regarding what deals to fund and to which sponsor
to lend. The due diligence process is protractive with a focus on new supply. Developers
must not only prove the market’s current rent structure but also defend future
rents in the face of new supply. Renewed emphasis on barriers to entry means lenders
need to understand exactly what will prohibit new competition in a market.
Lenders are not buying off on 24-month lease-up periods experienced earlier in
the cycle; in some cases, even 36-month lease-up periods are considered unrealistic.
Developments must be supportable in a slowing lease-up environment, and many
lenders won’t consider any rental increases in the first five years; in fact, some
actually underwrite lower rents in the future given new competition.
Combine these pressures with increased costs (land, materials, labor,
interest rates) and it’s difficult to find development deals that hold up to a lender’s
gauntlet of tests and questions. This is not to say there are no readily
financeable quality development opportunities out there, because there are. Rather,
it suggests that as we enter the final stages of this development cycle, lenders
are being prudent in their issuance of credit. Unlike 2005 to 2007, when lenders
were helping fuel the fire, this time they appear to be dampening the fire,
which may be a saving grace for our industry.