The self-storage industry presented two faces throughout 2017. On
one side, there were widespread reports during the first half of the year of decelerating
rental growth, revenue, and occupancy, and hints of discounting. In the second
half of the year, the storage real estate investment trusts (REITs) reported
robust occupancies and improved revenues.
Early in the year, REIT acquisitions were down substantially, but
it’s believed the public companies spent freely on portfolios in the fourth
Self-storage operators, consultants, and lenders were nervous
about the number of new developments sprouting around the country, but they
still pointed to pockets within oversupplied markets where new facilities could
Wall Street lenders and analysts have become more sophisticated in
their knowledge of the industry, so this news comes as no surprise to them.
Nevertheless, Wall Street still looks favorably on self-storage fundamentals
and tends to buy into the market.
“Returns year over year have been greater than other real estate
sectors and now, even at a slow-down pace, it’s still at a level equal to or
better than other property sectors,” says Neal Gussis, principal at CCM Commercial
Mortgage in Skokie, Ill. “Now that we’re getting closer to the end of the
cycle, institutions are looking at self-storage and saying it’s just as good as
other sectors, if not better.”
Some observers believe Wall Street is “cautiously optimistic”
about the state of self-storage. In fact, with the possible exception of
development projects in certain areas, the capital markets are flooding
self-storage with investment funds for acquisitions, refinancing, and
self-storage Wall Street lenders, the spigots are on high; they haven’t slowed
down whatsoever,” says Gussis.
Libert, a CCM principal, “If you put your mouth over the faucet of Wall Street
debt money coming into the business, you’d drown.”
This may not
be an exaggeration as many investors are eager to enter the storage sector.
Some of this money is contributing to the glut of new development, while other
funds are driving the prices of some portfolios out of the reach of the REITs.
A Drop In Acquisitions
Following several years of rising property values and a feeding
frenzy at the acquisition trough, 2017 turned out to be a year of reckoning for
many self-storage owners. Capital has been readily available, and many
potential buyers kicked the tires on facilities that were on the market, yet
there was a significant drop-off in acquisitions.
“We have ongoing discussions with owners, and they feel like it’s
a good time to be a seller, but are they ready to act? For them it’s a big life
decision to sell,” says Zach Dickens, senior vice president of real estate for
Extra Space Storage, a Utah-based REIT. “Some larger operators still like the
fundamentals of storage, so it’s always a question about what is a good time to
sell or should we keep building our platform? It’s still very enticing with
pricing today for owners to at least think about selling, but I don’t get a
sense that we are going to see a tremendous amount of volume.”
Through the first nine months of 2017, REIT acquisitions dropped between
63 percent and 70 percent from the previous year, according to real estate
brokers who study the REIT sector. While there are indications Extra Space and
other REITs opened up their wallets during the fourth quarter, it still appears
last year’s results were going to seriously trail previous years’ acquisition
Were REITs more selective in their purchases, or were sellers dug
in on their sales prices?
“REITs do a dance where they’re interested, but they can’t overpay
and destroy value for their shareholders,” Dickens says. “In the first half,
sellers put out feelers, and they weren’t getting the numbers they wanted, so
their inclination was to pull back. There is a point where the seller has to
reset their expectations based on market conditions.”
The lower acquisition activity was not limited to REITs. Wayne
Johnson, CIO of SmartStop Asset Management, reports the company’s acquisitions
fell to approximately $150 million in 2017.
“We looked at quite a few opportunities and bid on plenty, but we
were not going to get pulled up in price, so we watched many deals go to
somebody else who was willing to pay more,” Johnson says.
SmartStop is the sponsor of Strategic Storage Trust and other
public non-traded REITs based in Ladera Ranch, Calif.
Among the reasons for the dearth of acquisitions Libert cites are a
lack of supply and private equity coming into the market and inflating prices.
“Also, the bid/ask widened because sellers continued to think that cap rates
are going to go down, and they leveled out at a low cap rate,” Libert says.
It appears the substantial stock price hits the REITs suffered in
2016 may have caused public companies to become more cautious about spending
freely for acquisitions following several active years. “Portfolios were taken
out by the REITs in ‘14, ’15, and ’16, prior to the stock price hits on storage
REITs, and so they backed off and institutional investors stepped in,” Gussis
Following a -8.14 percent decline in stock prices in 2016,
self-storage REITs recovered to a modest 3.74 percent gain last year, according
to NAREIT, an advocate for the REIT industry.
Dickens believes Wall Street had a “prove it” mentality toward the
REITs at the beginning of the year, as there was a concern about slowing rate
growth. “We were coming off double-digit revenue growth years, and there was
clearly a slowing that was happening in rental rates,” Dickens says. “When it
became more evident through the first three quarters, people saw it wasn’t as
bad as it was reported to be.”
Private equity funds have had a profound effect on the face of
self-storage in recent years as millions of dollars of investment money came
into the industry from new sources.
“Institutional private money discovered self-storage over the last
five years and have been very aggressive over last two or three years,” Libert
says. “Institutional quality and competition was up from private equity in a
huge way, which raised sellers’ expectations way up.”
While the REITs may have shied away from mega deals, there was
still plenty of money available for storage acquisitions. For example, Sitar
Realty Co. announced in November the $124.4 million acquisition of 6,272
storage units across a dozen Northeast cities by Saratoga Springs-based Prime
Prime Group, a real estate company that owns self-storage and
other real estate interests, acquired a storage facility from Madison
Development in the Brooklyn, N.Y., area for $53 million.
While storage REITs CubeSmart and Life Storage had no acquisitions
in the third quarter, Tampa, Fla.-based SkyView Advisors reports that National
Storage Affiliates REIT spent $123 million on property buys during the quarter.
Late last year, Strategic Storage Trust II completed the purchase
of 11 facilities in Asheville, N.C., for more than $92 million. The acquisition
was the final phase of a 27-property portfolio initiated in March 2016. The
entire portfolio represents a combined investment of $371 million.
REIT volume appeared to pick up in the fourth quarter. “Our fourth
quarter was very active,” says Extra Space’s Dickens. “We closed more in the
second half of the year than in the first half.”
The fourth quarter activity may be a springboard to a better
transactions year. “The brokers believe that 2018 is going to be better than
2017 when it comes to deals coming to market,” Dickens says. “The question is
whether the REITs will be willing to come out in earnest and buy it up. Last
year it was private equity filling the void if the REITs didn’t want to get as
Storage’s Asheville acquisition could serve as a harbinger of more
headline-grabbing news from SmartStop. “We have quite a bit in the pipeline,”
Johnson says. “From our side of the table, it should be a better year if
sellers are willing to recognize interest rates are rising.”
SkyView reports that smart investors are taking advantage of the
current marketplace conditions to monetize their assets before this expansion
cycle comes to a close. Also, sellers may soon modify their asking prices.
“We are going to see many more reasonably priced assets coming to
market as less prepared owners try to get out late in the game,” SkyView says.
Financing May Wither
Construction financing has been readily available over the past
couple of years, according to the 2018Self-Storage Almanac. But the storage
industry’s current development cycle is producing a level of new supply that has
not been seen in over a decade. This will surely impact rental rates and
occupancies in saturated markets. Lenders know this and have scaled back loan-to-cost
funding for new construction.
“Construction money will be more difficult going into 2018 and
beyond, because lenders have seen this before and start to pull back,” Libert
says. “Lenders that were in the construction business in 2015 to ‘16 are more
measured in 2017 and will continue to be more selective in 2018.”
Dickens notes that more lenders today are placing self-storage
development in the high-volatility commercial real estate (HVCRE) category. HVCRE
properties are considered more speculative, since they typically don’t have
tenants at the beginning of construction.
The HVCRE rule, which went into effect in 2015, increased the risk
weighting of a loan held on a bank’s balance sheet by 50 percent. The rule
dictates that loans are required to stay designated as HVCRE until the credit
facility is converted to permanent financing, sold, or paid in full, according
to the American Bankers Association.
“What that means for developers typically is they aren’t able to
borrow as much on a loan-to-value basis,” Dickens says. “That entails limits on
making loans to HVCRE properties. That’s going to put downward pressure on the
amount of loans being generated.”
Banks, as well as other lending sources, are going to tap the
brakes on new self-storage development this year, although new stores will
certainly begin construction in areas where owners deem a need exists.
“It’s going to separate out lucrative new development deals from
marginal development deals,” Libert says. “Borrowing costs on new construction
is going up, but also we’re in a boom cycle now, so the cost of materials is
going up, so margins on development deals are getting compressed. Developers
are getting more selective on the deals they’ll do, and lenders are more
cautious, so it eliminates marginal development deals and less experienced
developers. Only the best deals with the most experienced developers will get
more attention from lenders.”
Self-storage has attracted interest from new investors since the
Great Recession, when the sector fared better during the economic downturn than
other real estate categories. Sources of capital for storage is expanding and
available for financing.
Commercial mortgage-backed securities (CMBS) have been readily
available for self-storage over the years, although this source has had its ups
The Almanac reports
total U.S. CMBS issuance reached $101 billion in 2015, marking the largest
annual volume since the recession hit in 2007. With the implementation of the
risk retention rule, several CMBS lenders left the market. In 2016, CMBS
issuance was down nearly 25 percent, but CMBS rebounded to over $86 billion in
2017, according to Trepp, a New York provider of data, analytics, and
“The CMBS market is as aggressive as ever in the self-storage
arena,” Gussis says. “They are offering interest-only periods up to 10-year
terms. That increases monthly cash flow when you don’t have principal pay down
for 10 years, so it’s maximizing cash flow for a 10-year period.”
Gussis says it’s still possible to get CMBS rates in the low four
CMBS loans are non-recourse debt products that typically feature
five-, seven-, or 10-year fixed-rate terms. Borrowers can achieve leverage up
to 75 percent or higher. Some CMBS lenders also compete for loans as low as $1
million in secondary or even tertiary markets. This is especially important for
self-storage owners with transactions in the sub-$5 million range.
Life insurance companies have been rising in importance in
self-storage lending. “Life insurance companies have gotten very aggressive
over the last year or two,” Libert says. “We’re closing loans with life
companies in 3.7 to 3.8 percent for 10 to 15 and sometimes 20-year fixed.”
The typical insurance lender prefers high-quality, stabilized
assets in core markets. Life companies have historically targeted loans over $5
million, but the current competitive landscape has encouraged some to stretch
for smaller deals, according to the Almanac.
To remain competitive and win deals, banks are increasingly
offering seven- and 10-year fixed-rate term loans at attractive interest rates,
with leverage available up to 75 percent LTV.
Credit unions have become an increasingly relevant financing
source for storage. While most banks prefer to lend in a designated footprint
that largely follows the institution’s presence based on relationships with
their existing clients, credit unions will lend nationally and often to a
borrower with no preexisting relationship.
loans, a local or regional bank is the most likely capital source for a
developer with a viable project. Lenders prefer guarantors with strong balance
sheets and significant development experience. Accordingly, banks are still
offering construction loans across the country, but are proceeding with
Small Business Administration (SBA) loans are made to small
business owners by a bank and are partially guaranteed by the government. SBA
financing has proven beneficial to self-storage owners in non-primary markets,
where traditional financing may be more difficult to obtain, as well as those
looking to surpass the typical 75 percent LTV threshold.
tend to be document-intensive, and the closing process can be lengthy. When
applying for SBA financing, seek out a Preferred Lender Program (PLP) certified
lender. PLP lenders can approve loans on behalf of the association, which can
speed up the process.
The Fed Damper
With banks tightening regulations and other lenders wary of
self-storage’s development growth, the Federal Reserve’s expected rate hikes
this year could put a further damper on capital for some operators.
“Fed rates affect short-term rates much greater than long-term
rates, so that would affect construction and bridge financing, because those
are adjustable loans that are pegged to shorter term rates,” Libert says. “The
jury is still out on how much that will affect the seven-year loan, 10-year
loan, or 15-year loan.”
The Fed rate hikes will affect the cost of capital for the REITs
as well as smaller operators. “You’re going to see a little increase in cap
rates, because people’s cost of funds is going up as a result of these hikes,”
Dickens says.“The question is, do
cap rates today reflect those increases already? The expectation of it going up
is often baked into deals today.”
Wall Street lenders will weigh several factors this year as they
consider further investments in storage.
today is looking at the major REITs and watching our performance very closely
to get clues about our ability to push rents,” Dickens says. “We’re
experiencing all-time-high occupancies among REITs, we’ve had outsized growth
for the last few years, but the question is, will that continue for the
foreseeable future? That’s where they’re trying to see if we’re able to keep up
the momentum we’ve been able to generate over the last few years, particularly
in light of new construction starts and those that are being delivered this
David Lucas is a freelance writer based in Phoenix, Arizona. He is a regular contributor to all of MiniCo’s publications.