Lending opportunities in the self-storage sector were once an afterthought for mainstream debt players hunting for the best returns. However, the segment garnered increasing interest from institutional investors, debt funds and more standard lenders in 2021, and is set to be one of 2022’s more interesting alternatives.
Debt plays within the sector have been on the upswing since the early days of covid, in line with where equity flows have similarly steered. Real Capital Analytics’ US Big Picture report published on April 21 showed first quarter 2022 volume for self-storage deals totaled $2.7 billion after recording $24.1 billion of new volume in 2021 and $8.4 billion of total volume in 2020.
Institutional investors especially have devoted larger allocations toward self-storage assets to fill out their private real estate portfolios, with interest in the niche on par with affordable housing, retail and medical office opportunities.
In a Nuveen survey of 497 asset owners published at the end of Q1, 21 percent indicated they intend to allocate more capital to self-storage real estate in the next two years. Self-storage interest narrowly trailed retail, which clocked in at 22 percent.
Here are the five things to understand about the self-storage sector in the current environment.
1 Institutionalization is steady on both sides
Larger lenders have poured into self-storage debt opportunities through the pandemic as the industry has become a more unified entity, with corporations replacing the prior mom-and-pop fragmentation.
Greg Michaud, head of real estate finance at Voya Investment Management, says the strain on office deals in New York City, San Francisco and other big markets drove eyes toward smaller markets and niche products where returns could survive broader market volatility.
The hunt for viable debt deals has been backed by larger, more established borrowers diving into the self-storage arena, too. Michaud says the increased attention and development being done in the niche has presented some concerns about overbuilding, though no foreboding signals have materialized yet. “It has been a great asset class through the global financial crisis and through the pandemic, and we are just not seeing a trend down in pricing for the units.”
2 Consolidation fuels innovation
The self-storage industry is no longer composed of just mom-and-pop entities, a fact that has added more stability for underwriting and sourcing wider deals in the current landscapes.
Brian Good, chief executive of Los Angeles-based bridge lender iBorrow, tells Real Estate Capital USA that having a larger management entity in place running the facilities creates more efficiencies when it comes to reporting, technology usage and potential expansion opportunities. “It is a pretty good investment for savvy investors,” Good says. “The yields are there; the returns are there. As a result, the institutional investors have leaned into the investment and made it harder for the smaller owners to expand and grab market share.”
Michaud notes the bigger owners and operators also have advanced software to figure out the lease-up process that mom-and-pop operations may lack. He says the efficiency created with a more corporate entity almost allows for airline-style seating on pricing for units.
3 Leasing is sticky
The only thing worse than having to move an entire batch of items into a storage unit once is having to move it twice or more. The general theory lenders such as Voya, iBorrow and others have acknowledged is once a tenant has moved their belongings into a unit, they are unlikely to transport them repeatedly.
This stickiness means once an asset is leased up, it generally remains so and provides more concrete terms to underwrite as a lender. Good says the lease-up period on self-storage assets will typically be slower and can take up to three years before a sustainable occupancy is reached.
Voya, in comparison, opts for full assets already maintaining a 70 percent or more occupancy rate to ensure the deal is a good fit for the core or core-plus buckets of the New York-based manager’s portfolio.
4 Oversaturation can sour opportunities
As with many things in life, it is possible to have too much of a good thing even when it comes to the supply of self-storage assets. Demand is certainly on the rise among investors, and flexible working conditions have only stoked tenant demand.
Michaud says the previous theory behind finding viable self-storage assets to lend on was to look next to multifamily developments where smaller apartment sizes may beget a need for additional room for tenants’ surplus belongings. Now, he says demographics drive the thesis.
“Building this stuff was never an easy task because nobody wanted it in their backyard,” Michaud says. “It was hard to zone. What we are finding now is old K-Marts are being converted to self-storage. Even old warehouses are being converted into this type of space.”
5 Location matters
The so-called best markets for self-storage assets to lend on look different now than in prior years, especially now with more flexibility around where Americans conduct their work on a day-to-day basis.
In a large metro area like Los Angeles, Good says it is important to consider self-storage tenants may be willing to drive to stow their belongings in cities such as Ontario, or elsewhere in the Inland Empire of Southern California, if they are only dropping in once or twice a year.
Assets located close to freeways and highways still bode well for drawing business but can come with a premium for their ease of access alone. American spending habits have also reshaped how the ideal self-storage facility looks and functions.
Michaud notes trailer and RV purchases increased through the pandemic, and without appropriate space in the driveway, new owners had to look toward self-storage facilities for a solution. Climate-controlled units are also seeing increased demand and, in Sunbelt markets, having the amenity on hand is essential for securing new tenants, whereas in the Northeast US it may be less of a necessity.