The self storage industry started long ago with sheds in a backyard. Its meager roots began as “mini-warehouses” as ancillary income for otherwise unusable land. Over the past five years, the industry has grown up and come into its own as a recognized commercial real estate investment. Self storage has grabbed the attention of private equity companies and real estate investors. Cap rates have dropped like a rock and development has increased to a frenzy. With so many people eager to invest in self storage, we must consider if self storage is a good investment.
Here are some reasons to invest in self storage:
Self storage is inherently more stable than other commercial real estate classes. Storage properties can range from 200 - 2,000 units which spreads the vacancy risk compared to retail with 5-10 units. In a business with five units providing revenue, losing 1 unit will result in a 1/5th drop in income. In a 500 unit storage business, losing 1/500th of revenue barely makes a dent. The diversified vacancy risk improves the stability of a self storage asset.
Self storage has a low expense ratio compared to multi-family or office. When a storage tenant vacates a unit, it merely needs to be swept to prepare for the next renter. Storage has little to no tenant improvements or make-ready costs. Compared to multi-family, there are fewer significant utility replacement costs as well. The most substantial expenses are property taxes, insurance, and labor. Labor is a hot button issue as more self storage facility are built to be fully automated. It is enticing to cut payroll costs by $40,000 - $60,000 a year, increasing the bottom line. However, having a property manager typically leads to faster absorption and stabilization of the property. Self storage expenses are relatively stable and predictable, making it an excellent investment as long as the numbers make sense.
Street rates and rate increases make up the rent revenue potential in self storage.
Street rates can be manually adjusted or preset to change based on specific qualifications. Similar to retail, the unit characteristic can drive the price. Retail can charge more for space that faces the street compared to the elbow. Storage units on the first floor are typically more expensive than those on the upper floors. Climate controlled units have a premium price over standard units.
Storage, unlike most commercial real estate investments, has month-to-month leases. While this may seem like a weakness to those who come from the long term lease retail world, it’s a massive strength. Month to month leasing allows rate increases to be issued with only 30 days’ notice. Smart storage owners calculate the average length of stay, and base rate increases off historical data.
Month-to-month leases also reduce the risk of locking in an under-market rate and remove the need for step-up rent standard in office or industrial real estate. Couple the ability to adjust existing tenant rates with the ease of changing the street rate and the diversified risk of vacancy, and you see why self storage is an excellent investment.
Day to Day operations
Self storage is an operating business, unlike some of the other commercial real estate classes. It’s more retail than industrial, and more multi-family than retail. “Self storage” encompasses a wide range of property types from 5 units behind a house to a 2,000 unit class A property on Main and Main. The day to day operations will fluctuate with the class of property, but tenants still need to pay each month, will have questions, and move in and out. The property needs to be cleaned and maintained. The bills need to be paid, and the accounting needs to be handled. If there is a full-time on-site manager, they will need to be trained and monitored to ensure they are running the property correctly. Although storage doesn’t have the headache of “toilets,” it’s far from a passive investment, unless you employ a professional management company.
Many storage owners treat the property as passive and neglect to adjust street rates, raise rates, tend to maintenance, or adequately market. With the drop in cap rates, these owners are losing millions of dollars by not running their property as they should.
Self storage used to be reasonably easy to build. The cost was low, zoning was straightforward, and demand was pent up. After 2006, self storage development halted for several years. At the beginning of the boom, storage was still reasonably easy to get off the ground. New development absorbed renters quickly, and occupancy hovered in the high 90% for most facilities. With the tariffs and increased construction costs, development is tougher. Land prices have increased along with construction, property taxes, and payroll costs. With an abundance in new supply coming online, rates have remained flat or decreased.
It’s getting harder to make the numbers work with traditional financing. Self storage requires more investment upfront and patient money. If your investment strategy can handle your cash sitting for 3-4 years, self storage may be an excellent investment for you. Sure, there are several creative ways to finance the property. Syndications, private equity, or private investor funding are all ways to get the deal done. However, when the REITs are sitting on the sidelines, waiting to acquire properties at a great deal because the developer couldn’t hit their projections, we should all be a little nervous.
If you are new to investing in self storage, be careful about the deals you choose to pursue. The two biggest risks in storage are: 1) It’s too small and can’t support itself and 2) demand isn’t there to fill the number of units available. Think about it logically. Revenue must exceed expenses. Income in storage comes from the capacity to rent to people who need it. You need capacity (size of the property) and people (market). It’s quite difficult to make 20 units in the middle of Nowhereville Population. 1 work, no matter how well you operate.
So, is storage a good investment? I believe so. I love this industry and am fully invested. To make storage a good investment, you need the right market, patient money, strong rates, and excellent operational skills.