During the course of my career, I have lived through a number of real estate cycles. I have seen the highs and lows from a number of different, unique perspectives: broker, developer, small portfolio manager and large portfolio owner just to name a few.
Like many of my counterparts in the self storage industry, I have concerns regarding our ability to sustain the pace of current development. Familiar trends from past decades are rearing their heads once more. It seems that every few years it’s time to revisit why the exuberance of a bull market is both a boom for some and an invitation to disaster for others.
My intention is not to be a harbinger of doom, but to help those who are new to the industry or thinking about getting involved know a little about our history and the path they will soon travel. As the old adage goes: you can’t know where you’re going if you don’t know where you’ve been.
The Savings and Loan Crisis
The first cycle I experienced was during the Savings and Loan Crisis of the late 1980’s and early 90’s. At that point, self storage was only starting to become a viable property type, not just a land play for redevelopment at a later date. The industry did not yet do a good job of collecting and sharing information. A lot of deals were done by gut and experience.
Prior to the S&L collapse, and the changes in the tax code that followed, lenders aggressively provided high-leverage loans to build new properties. Although this kind of lending was an outlier in regard to self storage, some early developers were caught overbuilding or building projects in inferior locations.
These overleveraged developers were unable to meet their obligation to the lenders when properties didn’t lease up as planned. As a result, lenders found themselves eager to quickly dispose of these repossessed assets.
The Resolution Trust Corporation, the organization in charge of liquidating these assets in the 90’s, was a great vehicle for the redistribution of wealth in the United States. Those with access to capital were able to pick up properties at bargain basement prices.
Through the mid 90’s, there was a limited ability to obtain reasonable financing, primarily because of lenders’ lack of understanding of our business. Development recovered even with the economic bumps along the road related to Y2K and 9-11. Self storage development was steady for almost 10 years after the S&L crisis.
The Subprime Mortgage Collapse
During the mid-2000’s, the industry was on the verge of a great transition. Better commercial and retail locations were utilized, construction quality standards were raised and larger facilities became more prevalent.
The true discovery of self storage as a viable real estate class reached a fever pitch as we made our way to 2007. Occupancy rates were high, rental rates were increasing, loans were available and we began to build at a rapid pace. By the mid 2000’s there were well over 2000 new facilities being built annually. Construction money was readily available to everyone from experienced operators to first timers. Self storage was booming. There seemed to be no end.
Self storage was healthy. We simply built so much new supply that some, actually many, projects just didn’t work or make sense. Most of which ended up changing ownership.
You heard a lot of people attempting to rationalize these risky ventures saying that not every project under consideration would be built, that somehow being first out of the ground would make a difference or their location was just that much better than the competition.
For some, this turned out to be the case. For most, the laws of supply and demand took over.
In many markets, new supply was prevalent and occupancy levels suffered. Rental rates were competitively marked down. Most facilities in lease-up stalled.
When Wall Street went up in smoke in late 2008, lending became much more difficult, if impossible, to obtain. Lenders were forced to take back projects. Again, not wanting to hold the assets, properties traded hands and were being sold either by the lender or owner for significantly reduced value, often well under the cost to build.
None of us were prepared for the depth or the length of time this recovery was going to take. Depending on who you talk to and the location of their facilities, most say we did not begin to recover until 2012 and it took us until 2014 to become a healthy industry once more.
During 2014 plans for new development started again. There is talk that 25 – 35 M square feet or 700 to 900 facilities were added 2016 with the same range added in 2017.
Here and Now in 2017
Here we are in 2017, a very healthy, robust self storage economy. I recall a lot of similarities to past cycles. The SSA is booming with record attendees and exhibitors at their state and national shows. Many new or first time self storage buyers and developers are entering the market. There is a build it and it will fill up kind of atmosphere.
I have spoken to so many of the people developing and asked if they have any concerns about all the new supply coming online. Again more echos from the past.
“The market is over 90% in that location.”
“It doesn’t make sense to phase, we’ll build all at once.”
“I’m being conservative with my numbers.”
“I’ll get out of the ground first.”
“Prices are too high to buy so we are going to develop.”
All of which may be true at points, but not often 100% of the time.
The construction process this time around is a bit different. Lenders have stringent underwriting criteria and construction money certainly isn’t flowing out of banks like it did in the mid 2000’s. The cost of land is higher and building is more expensive. The entitlement process is longer and more difficult.
That being said, there seem to be plenty of operators able to obtain leverage for their new projects. One of the reasons being there are now more experience midsize and larger operators.
Many of whom are building bigger, more expensive projects than ever before. It is not uncommon to see announcements of new development slated that will exceed $10 million and have over 80,000 square feet. I am amazed to see how many times I hear about projects over 100,000 sf feet being built.
Simply, these projects, even in the best of markets, will require several years to lease up. And will be impactful to their competitors.
This “bigger is better” trend is a reaction to the market. For a majority of these projects to make economic sense, large facilities must be built in cities with higher rents to support investment returns.
Given the increase in project cost and time to build, mostly larger, more experienced operators and institutions with large balance sheet sponsors are in a position to build.
Those of you who know me, know I am a positive, optimistic person. I am also paying close attention to these historical trends. We have better and more accurate data today than we have ever had in our industry. Yet, even with this improved information, I’m still hearing a lot of the same.
Will everything scheduled for development be built? No.
Is there too much supply coming online? In a majority of markets the answer is most likely yes.
Will there be exceptions? Absolutely, but few.
Will storage demand catch back up with the new supply? Of course it will, but in how long and at what cost?
Any way you look at it, over-supply impacts all self storage facilities in any given market. Rates are lowered, discounts and specials are more aggressive and absorption time is longer.
Self storage has unique demand and operating features which insulate us better than other real estate sectors. That being said, anybody that invests in real estate, including self storage, is exposed to dynamic market conditions.
Over-building and supply and demand are only parts of the equation. We learned in past cycles that there are many contributing factors to any adjustment in real estate markets; interest rates, availability of financing, ebbs and flows of the economy. As we move into this next cycle, investor and lender expectations need to be tempered in regard to lease up.
We are in a great real estate sector and a great business, but there is no doubt that we are experiencing many similarities to past cycles. We should all be cautious and prepared for the future as it is likely we will soon face headwinds.
The correction, in most areas, will not be as deep or last as long as it has in previous cycles. The thing to remember is that none of us, no matter how savvy or motivated, no matter how sophisticated our management, can beat supply and demand. I am hopeful developers, lenders and new money coming into our great business will do what experts like Dean Jernigan suggest: share data, build smart and know your markets.
I am not an economist, nor a historian, and I don’t pretend to be. Just a guy who’s lived it and wants to see the industry continue to thrive. To those new to the industry, jump on in! Learn from our past experiences and make your own way.
About the Authors
Don Clauson is the CEO of Strat Property Management Inc, a property management company based in San Diego that operates in California under the StaxUp Storage brand and in Texas under the Lockaway Storage Brand. Mr. Clauson serves as Treasurer and National Director for the Board of Directors for the Self Storage Association.
Neal Gussis, Contributing Author
Neal is a co-founding principal at CCM Commercial Mortgage where he provides mortgage brokerage and advisory services for all types of commercial real estate with a specialty in self-storage. Neal has sourced well in excess of $3 billion in financing as a direct lender and a mortgage broker. Over the past 23 years, Neal has had to continually navigate the ever-changing economic climates and be resourceful in created financing solutions utilizing various capital sources. His reputation as a main stay in the self-storage industry is unparalleled, backed by countless satisfied self-storage owners who have put their trust in him and his advice. Neal is also often asked to be a presenter in many of the national and state self-storage industry events.