The self-storage sector is a relatively new asset class within real estate investment that has shown tremendous growth potential over the past 10 years. What was once a mom-and-pop type operation, self-storage has since been institutionalized and now private investors are finding their way back into the space.
Self-storage, along with mobile home parks, has experienced more net operating income growth than any other asset class since the Great Recession. Investors who are looking to diversify, but prefer less management and maintenance requirements, are coming out of other property types and investing in self-storage instead.
Self-storage is a great opportunity, offering a higher yield and more diversification by spreading wealth across multiple markets with fewer management costs than typical real estate investments. The private investors are now a higher-caliber investor coming back into the market and aggressively competing on large and small deals.
Buying Trends of Current Generations
With an aggressive battle between supply and demand, there is a lot of development in self-storage, but consumer behavior is actually changing the use of self-storage through each generation. Baby boomers are a generation with wealth built up over time. They tend to use self-storage in the more traditional sense; an offsite storage facility where they keep belongings they don’t want to part with, but don’t need or use on a regular basis. They don’t tend to visit their self-storage units as often, at most maybe once a month.
The Millennial generation is now changing the dynamics of the self-storage space in the same way they have created “generation rent” when it comes to real estate. Living in smaller spaces and tending towards renting over buying, Millennials see self-storage as an extension of their closet. They store more lifestyle-based items like outdoor and camping gear; things they use on a regular basis, but don’t have space for in their homes. These self-storage users are visiting their units on a regular basis, sometimes multiple times a week.
Caution with Overdevelopment
The change in buyers of self-storage units is really what’s driving the demand for such development. Self-storage facilities are relatively inexpensive to build, so overdevelopment can become a problem if caution isn’t exercised. Construction can be a big issue. It was pretty high in the self-storage market in 2017, but came down a bit in 2018. In part because banks have tightened up their lending on construction loans for all property types. Banks are worried about overdevelopment and feel it’s too late in the post-recession cycle. That, coupled with rising material costs due to tariffs and rising wages, means the availability of construction workers is becoming more of a challenge.
Emerging and Oversaturated Markets
Supply risk is something everyone needs to consider as they invest in self-storage. It’s important to look at where the supply is and how it will be absorbed. You need to balance your supply and demand metrics with population and job growth in the area. The dynamics are different in each metro and more competitive than a few years ago.
Markets with a lot of growth and demand drivers can still pose as a risk when it comes to adding new space. Denver is a perfect example, where there has been a huge influx of population, but the overdevelopment of self-storage has tipped the supply out of balance with the demand. Charlotte and Nashville are other great examples of markets that are overheated. Minneapolis and Portland also present supply risks with too much competition.
When looking for emerging markets, it’s important to look at what’s happening with the economy as a whole and not just the supply and demand metrics. Las Vegas and the Inland Empire in California are two markets that stand out as particularly attractive in the short term. Looking at the drivers, we can see lots of job creation and population growth in these areas at the moment. Another factor is that these two markets were both hit hard during the housing downturn from 2008 – 2010, so developers are hesitant to go back there. This leads to less competition and a lower risk of overdevelopment.
Automation & Technology
Looking at automation and tech in the self-storage space presents a potential for even more growth. For investors, technology can work to the advantage of the self-storage sector. Anything that supports the customer experience is creating value. From an operations standpoint, automation could offer better management software, more convenience, and reduce staffing requirements. Safety and security is the bottom line when it comes to self-storage and technology will offer an advantage over older facilities.
The current state of the economy shows very positive signs right now. Unemployment is close to historical lows and we have been in a growth cycle for about 9.5 years now. In fact, we are just 9 months away from matching the longest growth cycle in history, which was recorded in the 90s. The economy is strong and we are seeing growth, but there are some risk factors out there which make investing a bit more sophisticated.
A top issue on everyone’s radar is what’s happening with interest rates and whether or not a recession is on the horizon. The cost of capital is an important consideration of any investment and the movement of short and long term rates can be indicators of another recession. The Fed was pushing rates hard last year and driving rates up, however that program stopped at the start of 2019 and interest rates have dropped since.
Yield spread between the 10-year Treasury and 2-year Treasury is continuing to bounce between 10-20 basis points (bps). There is considerable concern about the current risk of inversion, where the 2-year Treasury rate rises above the 10-year rate. Typically when you see a yield curve inversion, it is followed by a recession 12 months or so later.
The good news is we don’t expect a recession in the next 12 months, but it’s possible we will see one within the next 2 years. Most economists believe the coming recession will be mild. Self-storage tends to be resistant to economic downturns and the pending recession shouldn’t be a significant adverse factor, assuming it’s not a severe one.
Another factor to consider is a secondary demand driver caused by economic downturn. When people double or triple up on housing, or downsize their living arrangements to save money, they tend to put a lot of things in storage. Considering these factors, the self-storage space makes an excellent source of diversification for investors in the real estate market.