COVER STORY, JANUARY 2012

AN INVESTOR MAGNET
Institutional and private buyers crowd into self-storage space as healthy vital signs reflect improving economy.
John Nelson

The Texas self-storage marketplace has benefited from the bullish involvement of REITs, which have been active in the self-storage arena throughout the U.S. According to the National Association of Real Estate Investment Trusts, self-storage properties performed the best of any REIT sector in the U.S. in 2011, posting a total return of 31.6 percent year-to-date through November 30.

By comparison, total returns for regional malls, the next best performing sector, were 17.17 percent during the same period. The uptick in REIT performance proves that self-storage has emerged as a strong asset class and its excellent return potential should only propel the increase of activity.

Private Mini Storage, located at 7825 Katy Freeway in Houston, features 440 self-storage units, 45 wines storage units and 12 covered outdoor vehicle storage spaces.

In Texas, the self-storage market is enjoying strong fundamentals with rental rates stabalizing and vacancies decreasing. The improvement in fundamentals has led to heightened investor demand for self-storage product, which in turn has caused capitalization rates to compress (the lower the cap rate, the higher the
purchase price). That’s particularly true of Class A properties.

Another critical factor in the downward trend of cap rates is low interest rates. “Buyers are coming off the sidelines and saying, ‘Hey, I can take advantage of a 5 percent rate locked for 5 years,’” says Bill Bellomy, principal at Southern Storage Group, a full-service self-storage brokerage firm.

Cap rates have sunk to the low 7 percent mark in Texas, down considerably from the mid-8 percent mark in late 2010, according to Marcus & Millichap’s semi-annual self-storage report.

Self-storage is accessible to all levels of investors, whether a national REIT or a private buyer. There are four equity REITs in the self-storage sector nationally, and they all have a healthy presence in Texas.

Sovran Self Storage recently acquired 22 facilities in Texas in a $111 million transaction. One of the facilities is in Dallas, three are in Austin and 18 are in Houston. Sovran will operate the facilities under the Uncle Bob’s Self Storage brand.

Although generally most of the activity has come from REITs, private owners have been active as well. A-A-A Storage Stassney LLC recently acquired Granada Self Storage, a 576-unit property in Austin.

One reason owners are enjoying sizeable returns on their investments is that self-storage facilities only take 35 to 40 percent occupancy to break even from an operations standpoint, according to Clemente Teng, vice president of investor services for Public Storage. The Glendale, Calif.-based company owns and operates more than 2,000 self- storage facilities in the U.S. Even with such an alluring breakeven point, self-storage properties can become distressed if they’re over-leveraged, even with a healthy occupancy rate.

The four main MSAs in Texas — Houston, Dallas/Fort Worth, San Antonio and Austin — have been deemed oversupplied by Cushman & Wakefield’s 2011 Self Storage Almanac. There are 1,385 self storage properties in Dallas/Fort Worth, 1,315 in Houston, 480 in San Antonio and 444 in Austin.

The supply of self-storage facilities in Texas stands at 12 square feet per capita, well above the national average of 7.25 square feet per capita. In spite of being oversupplied, occupancy is relatively healthy, especially in San Antonio. The occupancy rate in San Antonio currently hovers around 89 percent, the highest occupancy rate of any MSA in the country, according to Marcus & Millichap.

The large supply has led to self-storage properties being more accessible in Texas than in other states on a rental rate basis. “Texas properties are more affordable, which opens it up to more potential users,” says Aaron Swerdlin, senior managing director of HFF’s Houston office. “It compensates for demand.”

Self-storage properties are in demand and tend to do well in both booming and struggling economies, according to Kate Spencer, associate director at Cushman & Wakefield’s Dallas office and a member of the firm’s Self Storage Industry Group.

“In periods of high foreclosure, people need a place to store their belongings because they’re downsizing,” says Spencer. “In good times, people are buying more things like boats and RVs, and they’re willing to store their stuff away from their house.”

Additionally, self-storage doesn’t become obsolete because the units require minimal upkeep. “It’s basically three walls, a roof and a garage door so it’s not as much maintenance as an office property,” says Teng.

A big draw for self-storage owners is the ability to adapt quickly to market conditions, an advantage that other property sectors can’t provide. Swerdlin believes that this feature is a contributing factor to the growth in investor interest.

“When inflation starts to creep in, owners can impose new rental rates immediately and on existing tenants 30 days from now,” says Swerdlin. “Self-storage can adjust to inflation faster than any other product type, except hotels.”

Although development is in a lull compared with the boom years of the mid-2000s, there has been some activity. The Storage Pro, a third-party self-storage property management firm, recently broke ground on a 77,000-square-foot facility that houses 534 units in New Braunfels.

The new facility shows that there is room for new developments in the marketplace, but Spencer says the conditions need to be ideal if it’s going to be a feasible project. “New construction is definitely a possibility if you’ve got the right market,” says Spencer. “If you’ve got the right market in the right trade area, one could be feasibly built.”

Development opportunities exist in undersupplied markets, such as McAllen and El Paso, which have 89 and 117 properties respectively, according to the Self Storage Almanac.

A hiccup that some developers are seeing is the preferential treatment of lenders for existing properties versus new development, because they have less of a default risk in refinancing an existing facility or providing acquisition financing than providing construction financing. “It’s harder for developers to get capital to build a storage facility than it is to buy one,” says Bellomy.

Even if development doesn’t take off this year, the self-storage sector in Texas is expected to perform well because the new year is primed for self-storage investor activity. Interest rates are not likely to increase drastically in an election year, capital has been the most liquid it has been in recent years and REITs will continue to seek out strong-performing assets. Spencer expects that self-storage’s strong performance in 2011 will continue right into the new year. “Right now, the self storage industry is going to continue to grow, even in these uncertain times.”

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