Slow But Steady

A Storage Forecast For 2017

While election pollsters are probably still wringing their hands trying to figure out what went so wrong in their election forecasts, many people associated with self-storage and financing are staying the course. Most are predicting that 2017 will be another good year for self-storage operators and some developers. But “good” is somewhat of an understatement considering that most of the the industry has seen record growth since recovering from The Great Recession.

“There’s some chatter about things slowing down,” says Aaron Swerdlin, executive managing director of NGKF Capital Markets in Houston, Texas. “This might sound like a bad thing, but the analysts still predict it’s going to be the number one performing business in commercial real estate.  It will be number one in the race, but by a more normal margin.”

To look at where self-storage is today and where it might go next year, we must first take a look at where it’s been and how it got here. 

First Generation to Third Generation

The self-storage industry has been one of the fastest growing sectors of the United State commercial real estate market for the past 40 years. An improved standard of living in the 1960s to 80s led to increased consumer demand for goods. In turn, this resulted in a need for space as people sought to store those goods.

Neal Gussis, principle with CCM Commercial Mortgage in Des Plaines, Ill., who has worked with self-storage since 1993, states that the industry didn’t know what to make of the product during that time period. “Back then, it was underwritten as one of the most conservative property types,” says Gussis.

Nevertheless, enough investors and banks saw the worth, and the industry exploded during the early 2000s. According to the Self Storage Association (SSA), the industry saw a 75 percent increase in demand from consumers for self-storage from 1995 to 2005. During that decade, the number of self-storage facilities grew to 40,000 and claimed 1.875 billion square feet of storage space. Average occupancy was at around 90 percent and there was a 24 percent increase in the number of self storage units on the market.

Those were the boom years. In 2007, the Great Recession hit the U.S. economy, which was also a year when more than 2,200 new facilities come online. That particular upcycle ended, but it didn’t necessarily mean the industry tanked. “We saw a little trouble in 2007 to 2011,” says Devin Huber, principle with the BSC Group in Chicago, Ill., whose company has been working with self-storage financing since 2001. “There was very little coming on line and supply that needed to be absorbed. There was some poor performance, and some owners struggled.”

However, as a whole, the industry not only survived the Great Recession but did it so well that some economists labeled it “recession resistant.”

In 2010, the market began to recover, and so did interest in new investments in self-storage, which has led to the current boom.

The Perfect Storm

“From the period of 2011 until 2015, I have never seen anything like it,” says Swerdlin. “There have always been upcycles, but there has never been a period like this—where the industry has benefited in every way at high levels.”

Intra Realty Resources, Inc., a market research firm that analyzes current trends, predicted that revenue for self-storage would hit $31.6 billion in 2015 and $32.7 billion in 2016. 

Selecting sites for new development and getting approval from local governments makes self-storage a very slow development. As the industry has matured from the old model of metal buildings to customized architecture meeting various city demands, it has gained a new reputation. But many cities still resist self-storage coming into their areas. “Cities live off of sales tax, and they want something on the commercial properties that will generate that,” says Ken Nitzberg, chairman/CEO of Devon Self Storage in Emeryville, Calif. “They also want industry that’s going to create jobs, and there is still a perception problem; and, while you’re waiting to get the project approved, there’s a chance the financing will go awry.”

Due to the relatively slow pace of self-storage development, the recession allowed for the industry to absorb all of the old demand. When development began slowly picking back up in 2010 to 2011, many of those new facilities wouldn’t come on line until 2016 to 2017. This meant that the current demand was still outpacing what’s available.

This allowed occupancy rates to continue to soar. Almost all levels of self-storage saw occupancy increased from the 80-plus percent range to 90 percent or above. According to IRR, REITs reported a boost in square foot occupancy from 88.2 percent in 2011 to 93.4 percent in 2015. 

Owners/operators also found they could increase rents. IRR reported that “rent per occupied square foot averaged 5.9 percent, with annual ranges from 5.7 percent to 6.1 percent. Operating expense ratios declined on a recurring annual basis for the past couple of years, mainly due to revenue gains outpacing expenses. Most notable is a net operating income (NOI) increase across the board. NOI increased 9.5 percent from 2014 to 2015.”

Gussis feels the industry is coming off of the “perfect storm” in 2015 to 2016 that created a very favorable business environment for self-storage. “There’s high occupancy, the ability to increase rents, the availability of capital, and cheap money [interest rates].”

Slower Growth Predicted
While the industry might look as good as it did just before the last fall, none of the experts believe there will be a major slowdown—even if the economy does. It’s estimated that around 1,600 new facilities will be brought on line in 2016 to 2017, which is a lot but nowhere near as much as 2007.

Although there is now over two billion square feet of storage space in the U.S., most markets will be able to absorb the new supply within a relatively short time (unlike when the recession hit in 2007). Still, as new supply is available, it will slow the “perfect storm” the industry has seen for the past several years to what can be described as a hard rain (in the positive sense).

“If I were to put 2017 in baseball terms,” says Swerdlin, “I’d say 2015 to 2016 was the World Series and we won it in four games. In 2017, we’re still going to win, but we might have to win it in seven.”

Operationally, occupancy rates may decrease in some areas or stay flat. As well, rental rates will not increase at the rates in which they have been in the past couple of years. “We will see a lot of pressure on rental rates,” says Huber. “I predict they won’t grow as much.”

Jeff Shouse, MAI, with Colliers International in Sacramento, Calif., agrees. “I think occupancy will stabilize, rent will stabilize, and we’ll stop seeing the sharp trends upwards we’ve seen in revenue and occupancy.” As a result, Shouse expects to see owners/operators having to give more incentives to drive new customers and keep existing ones.

On the capital side for planned new development, a lot will depend on the new presidential administration’s affect on interest rates, which have already begun to rise, as well as inflation, which is also predicted to rise, and the possibility economists are giving for a recession to hit in the next two years.

Be that as it may, projections for more multifamily housing are still high nationally, with an emphasis in high density areas such as Miami, Houston, and Dallas, which leaves a lot more room for more self-storage facility projects. This is good news for the storage industry.

Nitzberg points out, for example, that the Houston area has such a large square mile radius geographically that what matters is not how many storage facilities are built but where they are located,due to the fact that studies show consumers want to be within around 3.5 miles of the facility.

As land continues to rise, especially in the high density urban areas, many continue to see conversion projects as the more attractive option. Shouse, who estimates that conversion projects were less than 10 percent of all new self-storage five years ago, says that they make up around 25 percent of projects now.

For any project, though, the experts think the new year shouldn’t be a warning to anyone to stop looking for new opportunities in self-storage. “Bottom line: I think the market will absorb the new supply coming on now,” says Gussis. “I think if someone finds a deal that works they should still go ahead and do the deal.”

Kerri Fivecoat-Campbell is a freelance journalist based in the Ozark Mountains. She is a regular contributor to MiniCo’s publications. Her business articles have also appeared in Entrepreneur, Aol.com, MSN.com, and The Kansas City Star.