How to Invest in Self-Storage Real Estate
What is Self-Storage?
Self-storage rents out and leases space to individuals and businesses. Most people at one time rented a self-storage unit. A majority self-storage leases are on a month-to-month basis. Some of the largest companies in the industry are Extra Space Storage, Public Storage, and CubeSmart.
Currently the self-storage industry has a market size of around $39 billion dollars with an estimated 60,000 facilities currently operating in the space. While those are large numbers, they are about 1/5 the size of the apartment industry which is around $176 billion with an estimated 564,000 facilities currently operating*. What that means, is that this is still a largely untapped market.
Asset Class Overview
Self-storage facilities vary quite a bit in size, quality, and purpose. Some facilities were built ground up with the intention of self-storage, while others have been converted into self-storage. Converting warehouses and vacant big box retail stores into self-storage has gained popularity in the recent years. Facilities can be 1 story or multiple stories. There are 4 main facility types in the self-storage industry.
1. Drive up
4. Flex/Mixed Use
Drive up has historically been the most common type of self-storage and is usually what everyone thinks of when they think of self-storage. A bunch of rows of units that someone can drive up to and unload or load items.
Climate controlled has gained popularity recently and can be incorporated with Drive up facilities or as part of a multi-story facility.
Specialty facilities usually focus on a specific type of storage such as boats and RVs or wine and art.
Lastly, flex or mix use usually incorporates an office or warehouse as part of the overall facility.
Self-storage is a relatively new industry that emerges in the 1960s, and since then has been one of the fastest growing sectors of commercial real estate. In the early stages of the industry, most facilities were owned and operated as ma and pop shops, but as the industry as gained traction, more institutional ownership has come into the market. While it’s not the well-kept secret it once was, there is still ample opportunity for investors to score big returns on this almost recession resistant industry.
Threats in Self-Storage
In order thoroughly understand self-storage investing, an unbiased assessment of the biggest threats to investing in the industry is needed.
• Oversaturation – while this is market dependent, more and more people are seeing the power of investing in self-storage which has caused a dramatic increase in the overall number of facilities. With more and more markets becoming oversaturated with self-storage it’s extremely important to do your due diligence. In my opinion, there’s going to be a decent number of people who are betting big on oversaturated markets. I see this most commonly with new self-storage investors who heard from a friend that self-storage is a great investment and they decide to buy or build a facility without doing ANY research or due diligence.
• Misconception of operations – most people who find out we invest heavily in self-storage often tell me something like “that’s a great idea, I mean it’s basically a parking lot with some metal buildings on it so it’s basically a hands-off investment”. People who say that to me quickly show me their ignorance of the industry. We’ll get into this more later, but self-storage operations are a big deal and much more involved than most people think.
• Lastly, it’s a sellers’ market right now. CAP rates are at all-time lows in the self-storage industry so it’s been harder and harder to find deals that make sense to invest in.
Opportunities in Self-Storage
Now onto the opportunities that exist through investing in self-storage.
• Fragmented market – what this means is that while the industry has gotten more institution in the recent years, the majority of facilities are still owned and operated as ma and pop shops. This leads to a lot of opportunity as ma and pop facilities are usually not prone to extensive market research on rents or obsessed with operational efficiencies.
• High cashflow – when a facility is filled up and stabilized, it can be an amazing cash cow investment. Self-storage facilities are known to throw off cash returns in the 8-11% quite regularly.
• Recession-resistant – we’ll get into this more later, but most experts agree that self-storage is one of the most recession-resistant commercial real estate industries in the market.
Real Estate & Operations
This was mentioned before, but it’s so important it deserves repeating.
Self-storage is one of three asset classes that are operating businesses AND real estate businesses. The other two asset classes are hotels and senior housing. This means that the operations of the facility are vital to the success of the investment so having a quality operator is a must.
The biggest operators out there are Public Storage, Extra Space Storage, and CubeSmart. That being said, the price you pay for an operator is usually directly tied to how large the operator is. The larger the operator the more you pay for that operator. In our experience, bigger doesn’t always mean better, but whatever the operator, make sure you’ve done your homework to select a quality one.
Self-storage has proven that the industry can succeed in both economic upturns and downturns. People seem to continually find new and creative ways to use self-storage. During an economic upturn, you might see people use facilities as product warehousing for small businesses or equipment storage for larger businesses. In an economic downturn, people are usually downsizing into smaller homes and storing household items such as furniture or art into a self-storage unit. In general, most experts agree that self-storage is one of the rare industries that are fairly recession resistant due to the flexibility of the product being offered.
• Population Growth - Self-storage facilities are really impacted the residential population in the area. Hardly enough can be said about strategic location. Projects located on major roads where there are more than 10,000 cars per day passing the site is even a requirement for some investors. In general, the closer located properties are to a densely populated area, the better the performance of the project. The number of roof tops is a major demand driver.
• Consumer Habits - Consumer habits also impact demand. With the increase cost of housing, homes are getting smaller with less square footage, but consumers continue to buy more stuff. It used to be that the demand requirement was one unit for every 15 homes in the area. Today, it’s 6-to-7 homes per unit.
• Transitional Housing/Businesses - Another demand driver is transitional housing. During the great depression from 2008 to 2012, a lot of people lost their homes and needed to find places to store their stuff while they looked for alternative housing and new jobs. There’s less demand for that today, but now we’re seeing manufacturing coming back and companies advertising for employment. That means higher demand for storage.
Some of the trends in self-storage development is the need for more flexibility in our storage units. Customers are using the space in novel ways. For instance, small businesses use the space for warehousing. Pharmaceutical reps and clothing reps are using self-storage to store drugs and other products they sell to doctors and hospitals while clothing reps store their product lines.
Just like other types of commercial real estate, it’s difficult to overstate the importance of location. Cities want to force self-storage into industrial zones, but that’s not conducive to a good marketing program. Projects located in an industrial zone require significantly more online and offline marketing than other projects located in more residential areas.
Today, much more technology is being implemented in self-storage facilities than older properties have. It’s common to have cameras located everywhere on a property with HD TV recording everything. The locks on each unit are tamper-proof and management software can identify and record every person that enters the property and every time they open and shut their unit. Onsite apartments are becoming less common and some facilities don’t even have an onsite manager.
The quality of design over the years has also changed dramatically. The closer the project is located to an urban neighborhood; the more design quality is required. Some two-and-three story projects nowadays don’t even look like the traditional designs we’re used to. Another design trend relates to the number of temperature-controlled units. That unit mix is increasing.
Understanding Self-Storage Financials
If you’ve looked at other financials in the real estate world, self-storage projections shouldn’t look completely foreign to you, but there are some nuances that deserve some attention. First off, the main driving factor in a self-storage facility is net rentable square feet or NRSF for short. Most storage financials measure the net rentable square feet as a way to track expected revenue for the facility. Another common term you’ll see when perusing self-storage financials is the blended rate. The blended rate is simply the average rate of all units and is usually shown on a per square foot base.
One of the important things to focus in on when analyzing self-storage financials is the CAP rate used. CAP rate stands for capitalization rate and if you need a refresher on that, check out our webinar, the Beginners Guide to Real Estate Investing here. While self-storage CAP rates are good, they are generally higher than multifamily CAP rates. They also vary quite a bit depending on the market. In suburban areas for a Class A facility, you can generally expect to see CAP rates in the 6-7% range, while in an urban area, the same facility would probably have a CAP rate in the 5-6.5% range. Pay special attention to the CAP rate being used on an investment as this number has a major effect on the estimated returns of the investment.
So far, we’ve given you much of the same information we use when choosing a self-storage investment, but at this point, I’m going to break everything we’ve talked down to 3 simple key tips. Understand that these are the same things all the self-storage experts are doing to determine their self-storage investments.
First, focus on the demand drivers. Self-storage is so operationally focused that you need to make sure you’re buying or building a facility in the right area. The same self-storage facility in two different locations can produce extremely different financial results. Focusing on the demand drivers helps set up your investment for success whether in an economic boom or an economic downturn.
Second, here are self-storage experts that focus their trade exclusively on the industry. For example, there are real estate agents that have entire teams that do nothing but look at real estate deals. Other people do self-storage feasibility studies that can greatly help you focus on the demand drivers because that’s what they're looking at. Utilizing self-storage experts help you (1) avoid a bad investment and (2) maximize a current investment.
Third, understand the investment, understand the investment, understand the investment. And in case you didn’t hear what I just said, understand the investment. Don’t invest in something you don’t understand or that you have a myriad of unanswered questions about. Self-storage is simple enough that experts should be able to explain things to you, but just complicated enough that it’s easy to get confused along the investing path.
You’ll notice that all 3 of our tips are very interconnected. That’s because following one tip helps facilitate following another tip and so on. While nothing is guaranteed in self-storage investing, following these three tips will lead you to a much higher success rate than if you just wing it.
Self-Storage Exit Strategies
So, you’ve made your self-storage investment using the 3 tips just talked about, found a quality operator, and are now ready to exit the investment. What are your options? It’s important to understand that the self-storage market is a much smaller market than other asset classes. Therefore, I recommend usually a quality self-storage professional in helping you through the exit process. In general, there’s two main buyers in the self-storage market.
(1) REITS, groups such as Extra Space Storage, CubeSmart, Public Storage, etc., and (2) individuals or smaller companies. REITS are notorious for low ball offers, especially on the first offer or two so if you decide to try and sell to a REIT, I always recommend having your numbers locked down. If you rely on them to tell you what your facility is worth, you’re essentially guaranteeing that you’re selling at a discount. Individuals and smaller companies are a great option, but less convenient that going to one of the REITS. Lastly, one of the common exit strategies in self-storage is to do a portfolio sale. What this means is that you have 2, 3, or more self-storage investments that you sell all together. This is a great option because it can attract more institutional buyers which are usually willing to pay well for solid performing real estate assets.
*Info comes from IBISWorld