WELCOME

Log in to access your VIP LoopNet and CoStar experience.

Preferences applied

This feature is unavailable at the moment.

We apologize, but the feature you are trying to access is currently unavailable. We are aware of this issue and our team is working hard to resolve the matter.

Please check back in a few minutes. We apologize for the inconvenience.

- LoopNet Team

You must register your contact information to view secure information on this listing.
You must register your contact information to view secure information on this listing.

Secret’s Out on Self-Storage, but Sector Remains Seductive

Strong Fundamentals and Solid Outlook Lures Investment, but on What Scale?
(Getty Images)
(Getty Images)

Once a “well-kept secret” among niche investors, self-storage has steadily gained a reputation as one of the most surefire plays in the industry. But when put to the test — as all commercial real estate has been by the crises of 2020 — did its outlook emerge unscathed? During a recent webinar hosted by Marcus & Millichap, several investment experts and observers answered yes to that question, explained why, and admitted to wishing it was still their secret going into 2021.

Like any commercial real estate sector, storage is likely to “feel some pain” as a result of the macro conditions experienced last year, according to Rick Schontz, president and CEO of City Line Capital. However, “similar to the last economic downturn,” it will be one of “the last to go in and the first to come out — with really only one year of negative revenue growth."

Self-storage is “certainly more resistant than retail and lodging and even some market-rate multifamily assets,” he continued during the Dec. 8 event. “We’re not going to see large fluctuations.”

Vacancy rates in the self-storage sector, moderators noted, are at an all-time low. Its stability is owed to several factors, including its monthly lease model; relatively inexpensive rents of just $100-$200 per month; and a diverse tenant base, according to Founder and CEO of Merit Hill Capital, Liz Raun Schlesinger.

A subsector of industrial, self-storage’s solid fundamentals can also be chalked up to its steady demand, she continued. “It’s a demand-based product. Even if you don’t want to, you may have to go to the storage unit during a pandemic, whereas you’re likely not getting on a flight and going to a hotel.”

Self-Storage Demand Remains Strong

The market’s strengths are nothing new. But back in 2016, when Schlesinger launched Merit Hill with a push into the self-storage market, she was worried the burgeoning property type had reached its peak. She asked expert mentors of hers whether they thought there was still money to be made in self-storage — doubting, for example, whether millennials would ever rent. They assured her to be patient; that “They’ll behave like any other generation once they have wealth.” It may not be the sexiest sector, but storage certainly had some legs.

Fast-forward to 2021, and millennials are the firm’s largest customer base. “It’s part of their life,” she said. “They put their skis and their bikes there, and it becomes an extension of the closet, particularly in dense urban areas. It’s a different use of the product, which is a real positive,” she said, joking that her starkest competition is with an average household garbage can.

University students also proved to be an uncertain yet overall buoyant tenant base throughout the pandemic, as campuses repeatedly opened and closed for in-person classes, speakers said. Job losses and other economic conditions spurred move-outs in April and May, but the myriad dynamics had balanced out to a V shape in rental rates and occupancy by fall.

Street rents (simple averages not adjusted for location or quality) are now back up about 8% year over year, Schontz said, noting that his firm hasn’t seen a decline in occupancy since September, when it started pushing rents again. The uptick in street rents is 18% for Schlesinger, along with 8% in achieved rents.

For these and other reasons, the outlook for self-storage is positive, both agreed.

“I’ve been in the industry since 2006, and we’ve never had occupancy this high that I’m aware of,” Schlesinger said. “We’re all feeling pretty strong where we sit, but with COVID cases rising and a stimulus unclear, we’re not calling it a day.”

Can the Self-Storage Sector Pack in Even More?

Demand for storage stems not just from residential users. According to Schontz, the trend of e-commerce distributors using self-storage properties for last-mile, “just in time” delivery, for instance, could be here to stay. Owners of larger self-storage facilities with warehouse or other excess space should certainly look to distribution users as an alternative tenant.

More and more small businesses are also relying on self-storage as they ramp up their own e-commerce models, Schlesinger added. “We have a lot of pharmaceutical reps, for example, and we’re expecting an increasing amount of business customers over time.”

This type of evolving demand for self-storage facilities, along with steady fundamentals, have churned so much investment interest in the sector that the speakers were asked whether there’s room for any more. After all, there’s been a wave of construction for the past three years, Marcus & Millichap senior vice president of research services John Chang noted.

Admittedly, “it was more fun back when it was a well-kept secret,” Schlesinger joked. Now, she said, even institutional giants are throwing their weight around. Blackstone announcing its $1.2 billion acquisition of Simply Self-Storage in October, for example, “was a pretty big game-changer for the industry.”

“A lot of people are attracted to the risk-adjusted returns in self-storage, but there’s no free lunch. You can’t get a $1 billion dollar portfolio with the same returns you get by compiling that portfolio one property at a time.”

Liz Raun Schlesinger, Founder and CEO, Merit Hill Capital

Meanwhile, firms like hers have been doing quite a bit of deals across the country, even amidst the pandemic. “We bought 48 properties in 22 deals and we have another 15 under contract or through a signed [letter of intent] that we’ll be closing at the end of the year, and I think we sold around 20 this year. We had no intentions to sell, but we had some unsolicited interest that was really quite surprising out of the gate. And [Schontz] is right: the cash on cash that we're generating now on the portfolio we’ve built is so high that it’s a good product to hold if you have that ability.”

Cap rates vary widely among market type and asset class, speakers noted, but for the most part, risk in self-storage is typically low, resulting in less sensational returns. “REITs involved in the sector are typically trading in the mid-4s, and we’re having trouble finding the yield we used to in the sector, honestly,” Schlesinger said.

Chang dove in: “Based on where we see fundamentals going, where we see occupancies, rent growth and the consensus in the marketplace, I think there’s a lot of investors coming in and I think that is going to put pressure on cap rates and pull them down.”

Storage Thrives on Small Splurges

Still, opportunities in the sector abound, the speakers agreed. And despite the heavyweight investment firms’ interest, it may be easier for smaller investors focused on local markets to rake in more significant yields. That’s a dynamic that may play out more in this space, along with retail and industrial as well, in 2021.

The Blackstone deal notwithstanding, Schlesinger explained, it’s nearly impossible to find opportunities to buy a $100 million portfolio with great yields compared to the effect of buying one or two mostly occupied individual facilities with noteworthy cap rates. “A lot of people are attracted to the risk-adjusted returns in self-storage, but there’s no free lunch,” she said. “You can’t get a $1 billion dollar portfolio with the same returns you get by compiling that portfolio one property at a time.”

Schontz elaborated. “I think it’s more secondary than primary markets where you do find the best yield, and then from a scale perspective, if you aggregate 100 to 150 of those properties together, that will certainly attract institutional buyers.”

Development often proposes more attractive yields than stabilized properties do, especially as the bulk of new construction in many markets is absorbed, speakers noted. Lenders, however, have started to pull back a bit, Schontz cautioned. Creditors who had provided nonrecourse debt in the past now are trending toward only offering recourse loans, or are requiring a lot more equity, which he said will likely take a lot of developers out of the game.

Furthermore, the advertising spend for lease-up facilities can put a significant dent in net operating income (NOI), Schlesinger explained.

Technology is also paramount to the sector’s survival during the pandemic and beyond, Schontz explained, and the licensing of online reservation, rental and touchless self-service management platforms is often the purview of larger capital firms and big brands.

Nonetheless, smaller investors focused on a single market or a few properties, especially franchises, will likely be able to devote more time and energy to their assets and their expenses, which offers advantages to NOI as well.

The takeaway, Schlesinger concluded, is that though the sector is no longer a secret, there’s still money to be made. Smaller investors should certainly look to “go out and buy or build” a self-storage property, she said, if they keep one caveat in mind: “It’s not necessarily as easy as it looks.”