With an influx of investment capital and cap rates at an all-time low, the self-storage REIT sector is hotter than ever. According to Wall Street Journal real estate analyst A.D. Pruitt,“Self-storage facilities are now the biggest ticket properties in commercial real estate.” Investors are drawn to self-storage properties due to high margins, steady cash flow, and a unique ability to perform well in economic downturns.
Not only is self-storage hailed as a “counter-cyclical” property type, but the fundamentals are also intrinsically strong. Due to the unique nature of self-storage rental agreements, it is relatively easy to increase tenants’ rents, and thereby increase cash flow. Also, unlike other real estate asset classes, self-storage operators do not need to worry about tenant improvements or leasing commissions.
On a year-over-year basis, rental income is up 6.6 percent and occupancies are up 1.6 percent, currently hovering around 85 percent.
High Occupancy Levels
We are currently seeing occupancy at extremely high levels across the nation:
- On the East Coast, 2012 occupancy levels were at 85 percent: an increase of 350 basis points (3.5 percent) from 2011.
- On the West Coast, 2012 occupancy levels were at 83.4 percent: an increase of 210 basis points (2.1 percent) from 2011.
- In the Midwest, 2012 occupancy levels were at 86 percent: an increase of 140 basis points (1.4 percent) from 2011 and the region’s highest since 2008.
- In the South, 2012 occupancy levels were at 83.2 percent: an increase of 250 basis points (2.5 percent) from 2011 and the region’s highest since 2008.
The following metropolitan cities currently have occupancies at 90 percent or higher:
- Boston, MA 92 percent
- Columbus, OH 92 percent
- Washington, DC 91.7 percent
- Denver, CO 91 percent
- Baltimore, MD 90.4 percent
- New York, NY 90.1 percent
- Birmingham, AL 90 percent
- Philadelphia, PA 90 percent
- San Francisco, CA 90 percent
Last year, the four publicly traded self-storage REITs brought in an average return of 19.11 percent.
Large Market Capitalization
This high perfoming self-storage REIT sector has a market cap of $34.13 billion.
- $25.84b PublicStorage
- $4.34b ExtraSpace
- $2.06b CubeSmart
- $1.89b Sovran
- $34.13b Total
Investment Capital Pouring into the Sector
Over the last five years, there has been an average of $1.5 billion worth of self-storage investment sales each year. There was $2.1 billion worth of self-storage investment sales in 2012 alone–the most since 2007.
High Valuations and Low Cap Rates
A “capitalization rate” is essentially the return an investor is willing to accept for a given income stream. Investors settle for low cap rates because they believe the property is valuable and likely to provide a higher income stream over time. When it comes to self-storage, we’re currently seeing cap rates around 7 to 8 percent nationwide.
Cap rates for larger deals are 6 to 7.5 percent, whereas cap rates for smaller properties in secondary and tertiary markets are 8 to 10 percent.
- On the East coast, cap rates are currently in the low-8 percent range.
- On the West coast, cap rates are currently in the high-7 percent range
- In the Midwest, cap rates are currently in the high-7 percent range.
- In the South, cap rates are currently in the low-8 percent range.
A Saturated Market
There has not been much development as of late. In fact, there are less than 200 new self-storage facilities currently under construction. This is an extremely low number, especially when one considers that there were 2,600 facilities developed between 2003 and 2007.
From a macro level, we have seen less development, more consolidation, low interest rates, robust competition, and the highest valuations in recent history.
Cap rates for Class A storage assets in competitive areas, like New York City, are currently below 5 percent. These high valuations and low cap rates will likely continue until the next development wave.
Graphs courtesy of The Wall Street Journal and Forbes.com. Occupancy and Cap Rate data from Marcus & Millichap.