Self storage skyrocketed in demand during and after the pandemic. Most experts are remaining bullish on self storage despite a slight cooling of some indicators, such as rental rates and investment sales. A significant deceleration in development resulting from high interest rates, high construction costs and challenging financing conditions should also boost rents.
“Driven by the booming levels of residential construction and new space requirements triggered by life events—for consumers and businesses alike—the self storage industry has expanded in the last 10 years, more than any other real estate sector in terms of inventory growth,” observed Doug Ressler, business intelligence manager at Yardi.
One sign of the sector’s continued appeal is the entry of new players into the market. Silver Star Properties REIT shifted its focus from office, retail and light industrial assets to self storage. David Wheeler, Silver Star’s president & chief investment officer, cites what he regards as the sector’s tremendous upside.
“Occupancies are still well above the average levels over the last 10 years as rental increases (tapered) off significantly over the last six months to a year,” Wheeler said. “That will slow things down just a little bit, but I don’t see significant drops in occupancy in front of us. I do think that demand is going to take off again after that near term sort of flatline in rental increases, and we’re going to continue to see robust growth in rental rates over the next 10 years.”
Another noteworthy new entrant to the U.S. market is Ivanhoé Cambridge, the Montreal-based institutional investor. In June, Ivanhoé struck a deal with Safely Store Self Storage that will initially provide $400 million in equity. The venture will target ground-up development and redevelopment opportunities as well as acquisitions.
Riding tailwinds
A slew of demographic and economic tailwinds is contributing to self storage demand, among them employment and migration patterns. “As populations moved from urban to suburban, North to South and East to West, this created increased demand in markets that were previously oversupplied,” observed Luke Elliot, vice chairman of Cushman & Wakefield’s self storage advisory group.
The population is increasing while people are renting longer or, if they do buy homes, finding smaller footprints. Due to these trends, the 40-to-55 Gen X cohort is leading demand for self storage. Ressler noted. Following them are the Millennials age 24 to 39, who may need additional space because of work-from-home, growing families and increased spending power.
“Previous concerns that younger generations prioritize experiences over material possessions seem somewhat unfounded,” said Carlock. “During the pandemic, Millennials have demonstrated increased utilization of storage spaces and engaged in home-sale activities as they enter different life stages.”
Alternatives for ground-up development are also in the mix. Arcland Property Co. recently took a novel approach to adding a 103,000-square-foot property in Hanover, Pa. The facility was converted from a grocery store that been vacant for two decades.
Development caveats
For the near term, at least, there are also other factors that point to caution in self storage development strategy. “Despite a commendable pace of retail spending in the previous year, consumers wary of inflation may start reducing their purchases in 2023 if annual price increases surpass historical averages,” predicted Byron Carlock, partner & U.S. real estate leader at PricewaterhouseCoopers.
“Furthermore, the migration wave observed in 2021 seems to have subsided, as evidenced by a decline in demand for both single-family and multifamily housing in the market.”
For the moment, development has subsided at the same time that higher interest rates and lender caution have cut into capital flows. Projects are taking longer to advance from the planning stage, and constrained lending is having an impact, as well, according to Yardi Matrix data. As of June, the new product pipeline stood at 3.6 percent of existing inventory, a major dip from June 2022, when the pipeline was equivalent to 10 percent of inventory. From May to June 2023, the new supply pipeline got smaller in about a third of top markets tracked by Yardi Matrix.
At least one aspect of self storage development is relatively unaffected by changing market dynamics. Because the self storage sector is commoditized, staying competitive depends less on other asset classes and more on such factors as design and amenities.
“We never expect a new building to steal customers from nearby competitors, but we do know that newer product often captures unmet demand and new customer entrants,” said Ryan Gibson, president & chief investment officer of Colorado-based Spartan Investment Group. “We have also found that attractive and well-constructed developments boast a slight premium upon disposition, but storage has not been subject to the flight to quality that many other assets have.”
Target markets
Since self storage benefits from unusually broad demand, development and investment opportunities often crop up off the beaten path. “Increasing investment interest and narrower capitalization rates have motivated numerous traditional storage investors to broaden their criteria for property selection,” Carlock said. “They are now considering opportunities in smaller towns and locations further away from major urban centers.”
Depending on the consumer a self storage operator is targeting, different areas bring different benefits. Household formation, population growth, high density migration areas and job growth are all key trends Silver Star Properties looks for. “There are a substantial number of markets throughout the Sun Belt that have those characteristics,” Wheeler said.
Spartan Investment Group looks for significant development activity, years of population growth and significant employment drivers. These positive self storage tailwinds that are often found in Sun Belt markets are frequently aligned with those of the multifamily industry. It’s not a foolproof approach, though.
“That said, markets with great demand do not always mean great self storage rents,” Gibson warned. “There are many markets that have shown great growth but the storage rents don’t support development at the return levels we desire.”
Tell-tale searches
While multiple Sun Belt trends make the region attractive for development and investment, other regions should not be overlooked. “In terms of the overall popularity of the self storage service, it is New York, with its many small apartments and culture of moving frequently, attracting more searches for self storage than any other city,” Ressler said.
These searches have surged 61 percent increase since 2019, he continued. The city has historically been undersupplied, but owners and investors are taking notice. Yardi Matrix data shows a current development pipeline of new facilities representing 6.7 percent of New York City’s current inventory as of May. That’s the second largest in the nation after Orlando.
Other markets where self storage searches more than tripled from 2019 to 2022 include Houston, Phoenix and Orlando. Right behind them were Chicago and Los Angeles.
“Despite all the challenges the commercial real estate market faced over the last decade, one subsector has seen investor sentiment remaining firmly positive, and that’s self storage,” Ressler said.
Before making development decisions, a few fundamentals are important to consider even in markets that are attractive on paper. “Assuming you are comfortable with the rents, the supply and have stress-tested your pro forma—can you construct a facility for below acquisition cost?” Gibson noted as the next step in examining an opportunity. “In many markets an operator could purchase below replacement cost, which can be great for acquisitions, but not for development.”
“With so little differentiation from one facility to another, having a strategy is paramount,” explained Gibson. “Some developers focus on a micro market, being the only facility in a small radius. Others try to be first to market and beat the rooftops to a given area. The most important consideration is to formulate a thesis for yourself and rigorously study whether it will work in your market.”
Read the August 2023 issue of MHN.
