Sector focus: How self-storage has moved closer to the mainstream

The asset class is becoming more stable collateral in CMBS deals, says a new Academy Securities report.

The self-storage sector is moving nearer to becoming a mainstream asset class, with a new report from New York-based investment bank Academy Securities underscoring how the sector is becoming an increasingly large and respected component of commercial mortgage-backed securities deals.

CMBS deals have about $21 billion outstanding exposure to self-storage properties across more than 1,900 loans. As that exposure has grown, Academy Securities has tracked a shift from primarily conduit loans to more single-asset/single-borrower transactions.

Self-storage CMBS issuance was at $1.2 billion in 2020 and all in conduit deals. From 2021 to 2022, the loan volume grew from $2.7 billion to $4.5 billion, with the SASB breakdown growing from $730 million to $3 billion.

Stav Gaon, head of securitized products research and strategy at Academy Securities, said the shift has come as more investors are open to embracing alternative asset classes while trying to reduce exposure to other property types with higher risks and uncertainties.

Moreover, the shift illustrates a change going on in the overall CMBS market. “It’s not a coincidence to see some segments more heavily focused in SASB in 2022 just for the sheer reason that SASB issuance dominated 2022,” he added.

Similar to other non-core CMBS properties such as life science or studios, self-storage is receiving rising interest from investors.

“We must stress that the performance of the self-storage loans has been very good,” said Gaon, who added that the sector has seen a low delinquency rate except for isolated cases. “At least some of [the niche sectors] are making their way into the core spectrum.”

The self-storage national vacancy rate dropped to 10.5 percent in late 2022 after peaking at 14.9 percent in Q1 2020, the Academy Securities report said, adding that the current leveling-off vacancy rate suggested a clearer deceleration trend in 2023. Regarding rents of the facilities, climate-controlled (CC) units fell 0.5 percent to $167.0 in Q3 2022 compared with the previous quarter, and non-climate-controlled (non-CC) rents dropped 0.6 percent quarterly as well.

The ownership of self-storage remains fragmented, with six publicly traded companies controlling 19.6 percent of the facilities, 96 companies holding 9.8 percent market share and small operators taking around the rest of 70 percent.

Older vintages

About 48 percent of the CMBS storage exposure is to properties built before 2000, with the report noting that one of the outstanding trends in self-storage is that older properties are at a significant disadvantage across markets.

Since the barriers to entry for self-storage are relatively low, it is easier for new construction to gain advantages in certain markets. “[If] a very strong operator identifies an underserved market, they can pretty quickly come in and build new properties, and take away existing customers,” said Gaon.

As the solution, Gaon suggested self-storage sponsors can upgrade assets in a way that is less dramatic than the renovation of properties in the industrial sector. Common examples of upgrades include technological advances such as digital access and climate control units.

“You probably can more easily renovate an old self-storage property. It will cost less, and the tenants or the customers may be less particular or specific about their demands,” Gaon added. “Making the properties more modern, more inviting, and more technologically savvy gives a lot of advantage to the newer buildings.”

Limiting factors

Despite the increasing investment interest, the “natural limit” to the self-storage segment is attributed to both the current inventory and borrowers’ needs. “It is a smaller segment at the end of the day,” said Gaon. “You do not have as many self-storage borrowers as you have office borrowers or multifamily borrowers. So there’s going to be a limit to how much self-storage can dominate or be prevalent in CMBS.”

As the property type becomes a more sizable component of a loan pool, its risks will accordingly increase. “If the self-storage loan is number five [largest in a deal’s stack], that has an impact because it could represent 3 or 4 percent of the deal and hurt some of the subordinated bonds,” said Gaon. “That certainly applies to the SASB self-storage units.”