Is the Time Right to Buy Self Storage?

by Nancy Mitchell

In our area, we saw self storage facilities being bought and sold on a regular basis throughout past years and watached cap rates steadily decline.  There had been a flurry of activity, especially when Wall Street anointed self storage as a great place to invest your money and bankers realized that the default rate on self storage facilities was the lowest in the commercial field.

About a year and a half ago in our Mid-Atlantic region, we saw a large portfolio sell at just over a 7 cap in the suburban and rural markets.  Eyebrows were raised. Those facilities sold at a phenomenally low cap rate for their locations. Was this trend going to continue?  It certainly was a trend that any seller was glad to see and made any owner feel richer.

What Happened

What we were seeing was a group buying self storage throughout the country to build their portfolio, and they were paying top prices.  Other buyers weren’t able to buy at those levels.  Then when the financial markets plummeted with the sub-prime mortgage mess, the top buyer dropped out of the market.  Many of their self storage contracts never closed.  Last summer, during the fall of the sub-prime market, there was a noticeable decline in self storage activity, which was felt by brokerage firms throughout the nation, even a noticeable drop in the number of calls brokers were fielding about self storage properties.  Buyers, it seemed, were in a holding pattern.

Late in 2007, activity returned.  Late last year, we saw a few facilities sell at a high 7 cap rate.  Recent activity has brought cap rates back to the 8 to 8.5 range for the suburban and rural markets.  Thus, the end of ’06 and early ’07 were the height of property values for these markets.

What Does this Mean Today

Normalcy has returned.  Buyers are critically looking at self storage, and when they consider investing, they are looking at the upside to their purchase.

How discriminating are buyers before purchasing?  We recently had a conversation with one of the Top Ten national buyers of self storage.  Last year, he looked at 70 properties.  After doing his analysis, he placed offers on two and bought none!  This is not the seller’s market of the past!

What Buyers Want

We (all self storage brokers) have numerous buyers looking for good self storage properties.  Stabilized properties (or close to a stabilized property) at 85% occupancy will be the first to sell.  That’s what the buyers want. Buyers want to buy on actual numbers with as little lease-up risk as possible.  In today’s market, that becomes a problem, since there aren’t many of those properties for sale.  Those properties rarely go on the market unless someone is retiring,  dies, wants to cash out, or is just tired of the self storage business.

What’s in the Market?

We see some developers building and selling.  We also see owners who have been in business for several years putting their properties on the market that are not near stabilization.   These properties in lease-up are the hardest to sell. Sellers want to get an upside for their investment and time, and buyers want an upside to the risk that they will be undertaking.  It’s where a meeting of the minds takes place over price negotiation whether facilities will sell or not.

How We Can Help in this Process

We understand how investors make their buying decisions for partially leased-up properties. Over the years, we have built a Development Pro Forma, which shows interest carry and operating costs to hold that property until reaching a stabilized occupancy, and we show the potential upside to that facility. Our Development Pro Forma also projects how many months until breakeven and until stabilized occupancy, giving the buyer a road map to the full value of the property.  Sellers appreciate and understand where and how the property is being valued.  Buyers understand the risk and realize the potential profits.  Combining these creates a successful sale for all parties.

What to Do

It’s still a great time to buy self storage.  Interest rates are low, and financing is available at local banks. But what we are seeing is that buyers are becoming very choosy about location, occupancy, and are looking for the best fit for their situation – whether it is cash flow properties, upside to a developmental project or increasing demographics within a 5-mile radius.

From a seller’s standpoint, it is also a good time to sell. We still have a low capital gains tax rate in place.  Valuations are still near historic highs.  And buyers are willing to take on a property in lease-up, if it is priced properly.  The key today is to be flexible and creative.