JEFF BASS, SVP/Market Manager - National Self Storage Banking, TCF Bank
As real estate and economic cycles go, things are usually fine, until they are not. The old adage “better to be a year early than a day late,” applies to such cycles. The self-storage sector has enjoyed tremendous success for the last few years, and a rising tide has lifted just about all of the boats. While we don’t want to miss out on the opportunities in front of us, how can we think about managing against the risks associated with the next bottom of a cycle and/or recession?
Key risks include rising interest
rates, rising CAP rates, overbuilding in hot markets, and the impact of a
recession on operational performance. At TCF, we have seen a trend where
development projects are becoming tougher to pencil due to higher construction and
entitlement costs, higher interest rates to test the projected NOI against,
multiple development projects in the same submarket, and moderating rental rates.
Sometimes the solution is more equity, thereby moderating the risk of
defaulting on the debt down the road.
Speaking to oversaturation, I
remember when we were working with experienced operators who emerged from the
last recession in pretty decent shape, but they did have a few exceptions in
their portfolios. In two specific cases, they each opened an 80,000-net-rentable-square-foot
facility within a mile of another competitor’s newly built 80,000-net-rentable-square-foot
facility. It was late 2007, going into 2008, and no one blinked. Sure, they all
eventually stabilized, but one took five years and the other took six years to
do so. The slow lease-up proved challenging for both the operators and their
It is important to look at the
supply/demand characteristics of a submarket that appears ripe for development.
Let’s say the submarket has excellent attributes, including below equilibrium
supply. But what if rather than one or two facilities being built at nearly the
same time in the three-mile radius, you have three or four? Logic would have it
that the lease-up will be harder with more facilities facing off against each
other at the same time. Add in an economic downturn (can you say loss of
discretionary renter?), and you have a recipe for problems.
When financing value-add
acquisitions or development, a key component is the right amount of equity. Given
that most agree we have peaked in the current real estate cycle, more equity is
prudent going forward. Be sure your loan structure accommodates a slower
lease-up, higher interest rates, and higher CAP rates. This approach lowers
refinance risk and default risk.
To find opportunities going
forward, more scrubbing will be required, and ultimately rewarded. Be willing
to pass on something that is too much of a stretch. Now is the time for greater
As Mark Twain once said, “History
doesn’t repeat itself, but it often rhymes.” By being pragmatic in our approach
now, we can continue to prosper while also preparing for future inevitable challenges.