Publications

- April 1, 2021: Vol. 8, Number 4

Core storage: Self-storage outperformance gains notice during pandemic

by Larry Braithwaite and Cassidy Toth

COVID-19 has firmly cemented self-storage’s place in the conversation about core real estate property sectors. Within the past decade, the rapid growth in self-storage inventory reflects not only strong growth in use among the overall population, but also strong and growing investment interest from public and private investors. The sector boasts enviable attributes, resulting in net operating income (NOI) growth with modest volatility and total returns that have exceeded each of the four major core property types for nearly 15 years. These superior investment returns have been aided by the sector’s high operating margins and limited ongoing capital expenditure requirements. Furthermore, superior rent-roll diversification mitigates single-tenant credit risk, while inelastic demand from sticky tenants and modest relative supply have helped contribute to landlord pricing power and long-term NOI growth. Although many of these attributes have been widely recognized over the past decade, the COVID-19 pandemic has highlighted the sector’s recession-resistant attributes less familiar to many investors.

RECESSION-RESISTANT ATTRIBUTES

Historically, self-storage’s ability to deliver consistent NOI growth has been evident even during recessionary periods. When job losses occur and workers face increasing economic insecurity, mobility tends to increase as people relocate for better economic prospects or more-affordable living situations. These transitioning households tend to increase demand for self-storage, a dynamic well demonstrated during the ongoing pandemic. Millions of Americans have lost their jobs and were forced to move or face the threat of eviction or foreclosure. In addition, young workers, overrepresented in the hardest-hit occupations, saw their unemployment rate jump from 8.4 percent to 24.4 percent from spring 2019 to spring 2020, according to research by the Economic Policy Institute. Given economic insecurity among this group amid crushing student-debt burdens, many decided to move home with their parents.

Higher-income workers less economically impacted by the pandemic drove a more than 20 percent year-over-year increase in home sales in September and October 2020, as many people accelerated their plans to move to single-family homes with more space to shelter in place comfortably, according to a report by the National Association of Realtors. Outside of these factors, a number of idiosyncratic dynamics unique to the pandemic helped to propel self-storage fundamentals even further. Restaurants and small businesses adapting to social-distancing mandates, or even temporarily discontinuing operations, contributed to absorption — small businesses comprise a substantial share of total self-storage demand. In addition, with rapidly growing ecommerce logistics demand and record-low industrial vacancy rates, small tenants are being pushed out of traditional industrial space, and they are increasingly turning to self-storage for their warehousing needs.

Work-from-home and learn-from-home each required space optimization through decluttering, while remote learning for college students required self-storage to bridge the gap of temporary dislocation. All the while, tens of thousands of millennials left their expensive urban apartments for more affordable opportunities to work remotely — either moving in with parents, or to their new favorite city or destination.

THE RELATIVE OUTLOOK IMPROVES

While returns for retail, office and many multifamily investments have softened during the pandemic, self-storage values have held steady, and many properties registered an uptick in NOI after a brief pause at the height of the pandemic. This relative strength has caused many investors to take notice. Recent large self-storage trades underscore investor demand for the sector, including Blackstone REIT’s $1.2 billion acquisition of Simply Self Storage; StorageMart’s recapitalization, led by investors including Bill Gates and sovereign wealth fund GIC; and Public Storage’s $528 million acquisition of a 36-property portfolio from Beyond Self Storage. Occupancy among the publicly traded self-storage REITs hit an all-time high during the pandemic, while move-in rates surged 15 percent year-over-year in November 2020, according to company disclosures. Considering the adverse impact COVID-19 has had on the overall investment outlook, self-storage arguably offers superior performance potential with less risk, compared with most core real estate asset classes.

OPERATING RISKS

Although self-storage has delivered compelling historic performance, investors making allocations to the sector today should consider risks unique to today’s investment landscape and other risks inherent to the asset class. Historic excess demand has helped drive landlord pricing power and NOI growth, but significant new supply in many markets has challenged fundamentals. Because a majority of users live within a short drive of their storage units, an in-depth understanding of fundamentals within the three- to five–mile trade areas surrounding a site is necessary to help identify the level of potential supply risk. Typically, facilities with seasoned rent-rolls featuring higher percentages of long-term tenants are more insulated from the threat of competing supply because these facilities have lower tenant turnover; in-place tenants are less likely to canvass the rental market and find potential savings worth the inconvenience of a move. The threat of new supply is much greater when new facilities are competing directly for new tenants, many of whom only require space for a few months, forcing landlords to offer steep discounts and deep concessions for extended periods, which typically results in prolonged time frames to reach stabilization.

Idiosyncratic self-storage operating dynamics are best navigated by operators specializing in the asset class. Because most storage customers begin their search online, a significant online presence, coupled with search-engine-optimization expertise, is paramount, and operators with larger footprints can capture online marketing and branding economies of scale. An experienced operator also can drive revenue optimization through upselling insurance and storage products, while truncating lease-up timeframes through skilled unit pricing. Owners entrusting management of their self-storage assets to less-experienced operators are likely to face a significant competitive disadvantage.

A FAVORABLE OUTLOOK

With deployment of COVID-19 vaccines under way, market participants are calibrating how self-storage will be affected. Although a full reopening of the economy will reduce a portion of recent stepped-up demand, the expected lengthy distribution period for the vaccine suggests pandemic-related demand is likely to persist for much of 2021, if not longer, and any potential reductions in tenant demand are likely to occur over time, easing the impact. Furthermore, demand from office employees working from home during COVID-19 could be sticky as many continue the practice post-pandemic. National storage usage has quadrupled from two square feet per capita 20 years ago to eight square feet per capita today. This upward trajectory should continue, with more stores located conveniently to infill suburban and urban housing, and with enhanced amenities and services, including expanded store footprints for greater convenience, year-round temperature-controlled units, improved lighting, heightened security, more-attractive aesthetics, 24-hour access, and digital-marketing innovations. In the medium to long term, demographic shifts should provide added momentum for storage, including millennials continuing to enter into the family-formation phase of their lives. A majority of storage users live in single-family homes, consequently the demographic-driven shift to single-family housing, supported by the booming single-family-home rental market, bodes well for the storage sector.

 

Larry Braithwaite is senior vice president and portfolio manager at ASB Real Estate Investments, and Cassidy Toth is head of research at the firm. This article is from a series of ASB reports on the impacts of the global pandemic on real estate investing and markets.

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