Investing in Self-Storage, a Recession-Resistant Asset
Self-storage is one of my favorite commercial real estate asset classes. As you’ve probably gathered from my previous posts, I am an investor in “alternative investments”, namely commercial real estate. As a busy professional, I’ve come to the conclusion that one of the best ways to invest in real estate is as a passive limited partner in a commercial real estate syndication project. I leverage the time and expertise of professional operators, and make a relatively high risk-adjusted return. After the initial due diligence and investment, I assume a completely passive role. No tenants, toilets, or termites. There are many subtypes of commercial real estate assets like multi-family, office, industrial, and retail. In previous posts, I introduced multifamily investing and shared one active deal in my portfolio.
Typically, when you think of real estate, self-storage does not immediately come to mind. But self-storage is another subclass of commercial real estate and has been around since the 1960s. More recently, it’s become a more mainstream investment and has attracted the attention of private real estate companies. There are opportunities for the accredited investor to invest directly in self-storage facilities. For the non-accredited investor, self-storage REITS are an option.
Americans own a ton of stuff. We are a consumerist society and as people continue to accumulate things like furniture, clothing, toys, and other knick-knacks, they need room to store them. People are generally reluctant to discard or donate their belongings for whatever reason, and their homes can no longer contain their growing stash of “things”. The rental population is increasing as the two largest demographic populations, millenials and baby boomers generate demand for multifamily apartment living. Apartments offer less storage space to tenants than single family homes, so this drives demand for more space. Storage of goods has become a burden for many middle-class families and individuals. In addition, self-storage has become a depository for disrupted lives; the deceased, divorced, displaced, downsized, and the dislocated. Self-storage solves these problems by allowing people to offload their belongings for an affordable monthly rental fee. Renters can keep all their stuff in a convenient, accessible and secure facility.
What is self-storage:
You’ve probably driven by self-storage facilities. They are non-descript buildings that can contain up to several hundred box-like rooms of various sizes. The smallest units are 5’x5’ and can be as large as 10’x30’. The properties can be single-story drive-up or multistory with elevator access and internal hallways. Offered features include 24 hour access, climate control, video security, and automation. Some offer specialized storage services for boats, RVs, wine and art collections. Properties may also operate complementary businesses such as U-Haul rentals, and packaging services. The customer pays a monthly rental fee for usage of their allotted rental space.
There are more than 54,000 self-storage facilities in the US generating $33 billion in revenue. Ownership and operations of these facilities is highly fragmented. The largest owner of self-storage facilities is a publicly traded REIT called Public Storage, which owns approximately 6% of the total self-storage square footage in the U.S. The five largest self-storage owners collectively own only 13% of the total square footage with the other 87% owned by small private regional operators and “mom and pop” shops. The smaller operators may have management inefficiencies which create value-add opportunities for larger operators.
The bulk of tenancy for self-storage units is residential (70.4%). The nation’s homeownership rate is at an all time low of 63.4%, the lowest it has been since 1967. The increasing number of renters drive demand for a couple reasons. Renters move in and out more often than homeowners, and urbanization pushes renters into the city, with smaller and denser housing and limited storage space. Combined, this means renters use self-storage at a higher rate than homeowners.
Millennials, the largest demographic group in the U.S., are delaying homeownership and renting longer, increasing the probability for them needing a storage unit.
Baby boomers are downsizing their living arrangements but still need a place to store all of their belongings.
The average lease term for residential self-storage is 13.4 months.
Businesses have grown in recent years and more small and medium sized businesses rely on storage facilities to hold their goods and equipment. Self-storage units are cheaper than commercial facilities and also provides term lease flexibility.
The average lease term for commercial self-storage is 25.2 months
College students use self-storage during summer break when their housing tenancy ends but they still need a place to store their belongings.
During overseas deployments, military personnel have a need to storage.
The average lease term for military self-storage is 12.7 months.
Reasons for owning self-storage:
Self-storage facilities have relatively low construction, operation, and maintenance costs. They are much less expensive to build than multifamily, retail, and office buildings. And since there are no tenants living in the space, operating and maintenance costs are also significantly less. When a tenant vacates, unit turns involve simply sweeping out the space and renting it out to the next tenant. There is no need for deep cleaning, carpet change, painting, remodeling, and other tasks. New technology such as automated entry, kiosks, remotely controlled systems, and computer software can reduce or eliminate the cost of personnel staffing.
Self-storage facilities sell merchandise like packing tape, boxes, and locks to generate additional revenue. Some facilities also generate revenue by serving as U-Haul rental stations. All of this adds to top-line revenue and increases NOI.
Easier eviction process:
A delinquent customer that stops paying rent can be evicted in 30-60 days and the contents of the storage unit can be auctioned off to recoup past due rent.
Break-even can be as low as 60-70% occupancy. This is much lower than other property types which lowers investor risk and allows the more flexibility to deal with economic fluctuations.
Self-storage investments can be recession resistant (but not recession proof).
In 2008, the NAREIT All Equity Index lost almost 40%. Not the self-storage sector REITs. They returned 5% including dividends. During economic downturns, individuals and families may need to downsize their homes to save money, but they still need a place for their “stuff”; this increases demand for storage facilities. This is one of the most important reasons I like self-storage. Some sources claim we are in the later stages of the commercial real estate cycle and I would rather be invested in something that can weather a downturn better than other asset classes.
High Sticky factor:
Renters are slow to move out once they’ve rented space, so there is less turn-over. It’s a lot of work to move and people hate moving. That also means they will tolerate rent hikes. Tenants don’t want to spend a whole weekend renting a truck and moving their stuff from one storage facility to another to save $20 a month. But a $20 rent hike on a $150/month storage unit is a 13% increase to the bottom line for the owner. In a sense, there is a captured audience
Specific pricing model: The operator has the flexibility to increase or decrease rates for a particular type of unit. For example, a 10×10 climate controlled unit may be in high demand so the operator can price that unit type at a premium. Consequently, the operator must be diligent on conducting local market research to optimize rental rates.
Wide moat: There are obstacles to self-storage development. The industry does not bring jobs or provide housing like apartment buildings, retail, and offices. NIMBY attitudes toward self storage make it difficult to gain government approval and zoning. Neighboring residential owners think they are tacky, and may resist development. Self-storage buildings are relatively easy to build, and therefore not a bonanza to contractors.
Even though self-storage is recession resistant, investing in this asset type comes with risks.
Poor economic conditions, increasing supply, and higher competition will increase vacancy and/or decrease rents. Poor operator management leading to slow lease-up will eat into monthly cash flow. Environmental risk factors like flooding can damage properties. The business is also sensitive to marketing efforts and good street visibility.
How to Invest:
Direct investment into this type of asset class is usually limited to the accredited investor. Since it’s a smaller asset class, with fewer operators than say multi-family or office, there are fewer investing opportunities. You can find a few on real estate crowdfund investing sites. Otherwise, most of these opportunities are sourced through investment groups and word of mouth, so you do have to do some digging to find these deals. The non-accredited investor option is indirect investment through a self-storage REIT. Personally, I choose to invest directly in individual deals as an accredited investor. This way, I can choose a strong sponsor and a specific property that has a compelling story and significant value-add opportunity.
In summary, self-storage can be part of a well-diversifed investment portfolio. It is more recession resistant than other types of assets which is one of its most attractive feature. Next time, I will present one such self-storage property I am invested in.
Invest in Life
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