The End Of Self StorageMay 25, 2022
Is self-storage, a risky investment? In general, any investment, any business, anything really is just as risky as the people that are doing it and running it. Now, why this is such an interesting question is because I think there are a lot of misnomers around it. What I'm going to have to say here is probably different than what you expect.
I am probably the largest self-storage cheerleader myself, with the largest self-storage podcast (Self-Storage Income), which hundreds of thousands of people listen to. I have bought more facilities this year than we have in any year prior. I am building 650,000 net-rentable square feet at this current time. So, I am a huge believer in the asset class, I am a huge believer in the future. I have been in this space since early 2000, so I went through the great recession.
Now, the asset class as we know it has changed. Self-storage is the newest asset class on the block and commercial real estate, right? Prior to 2008, it was not mainstream. When we were first starting to buy storage facilities, we were insurance salesmen and we were told by one of our co-workers, “So, you’re going from being insurance people to slumlords.” That was the perception of self-storage at the time, and it still is in a lot of places, but the way that consumers use self-storage…the product they're putting out…it's all changed.
This change is what’s important, because how we view the asset and how we view whether this asset will do good or not…its overall return associated with its risk is all predicated on its past and how it's survived a lot of things.
So, let’s go back to the great recession. In 2008, Self-Storage gained a reputation. And we hear a lot of echoes from the great recession in the philosophy and the overall thinking of self-storage now. The first thing that I noticed was that the vast majority of people that talked about it did not own or even know what self-storage was during the great recession. That’s because, after the great recession, self-storage really took hold in investors’ minds. Over the last five years, we've had a swarm of new capital diving into this investment class. It has been the greatest period of returns, asset appreciation, and increase in overall revenue (price per square foot) with this asset class that we’ve ever seen. This has created a massive theme with all these investors that are new into the investor class that has been lifted up by the market and we see a lot of them that really don’t understand how this asset performs in any other kind of conditions or why it did what it did during the great recession.
They say, “even if there’s another 2008, we saw how self-storage performed during that time.”
They say it's “recession-proof” or “recession-resistant” and this is where I start to have some issues. The reason being is the performance of self-storage during the great recession and how we view it today was predicated largely on two things:
- Occupancy during that time
- Overall defaults
So, how many of these self-storage facilities went under, defaulted, and what happened with occupancies during the time of which it blew out any other asset class and had the lowest defaults, had the highest occupancy, and everybody looked at some cheese. This is incredible. The reason why I believe in no way, shape, or form that self-storage will do what it did in 2008 today or beyond is because of the change in the asset class.
So, let's go back prior to 2008. Nobody really wanted anything to do with it, right? That means banks also didn't want anything to do. It was very hard to get financing for self-storage. Now, although it was the lowest defaulting out of all major commercial real estate, it also had the lowest debt to revenue and value. The debt-to-income ratio was lower, and the LTV was really low in storage because it was forced. Banks didn’t want to refinance to let people take out more money, banks didn’t want to loan. We had to put a lot more money down, we had to keep a lot of money in our accounts, and this was fundamentally due to the perception that self-storage is extremely risky. That was because the leases were month-to-month…they weren’t long-term. So banks didn’t think they could project out the revenue as they could in apartments, or retail, or housing. Self-storage facilities see occupancy changes all the time…it’s always moving…it was dangerous to them. So, in turn, you had to have a lot of equity in them. They had to perform well in order to get the banks involved.
When we compare the two assets, performance is skewed. There weren’t as many defaults, but when I look at performance, I care more about what happened to the income. This is where I think people get very, very confused. During the recession, we bought lots of assets that went under – self-storage facilities – and the ones that didn't…that were still around, they may have had 85-90 percent occupancy, but the revenues were cut in half. But they had low debt. They had favorable debt. They could survive that, and they could keep occupancy high because they could give that away and as people were moving around and changing, they could say, “I’ll give you one month, I’ll give you two months free.” And people would come in! You can't do that at the apartment building, right? You can't say I'm going to give you one month free or not and just have people sitting around. First, your debt’s high, and you need to pay your bills; and second, during that time you had lots of syndicators and lots of different structures. Refinance processes on the bank loans and the notes that covered those assets, they never would have allowed that. So, we had lots of people that were renting storage through the Great Recession that wasn't even paying, but the asset could still function.
Now, the second part that people don’t realize: since 2008, we have now seen the largest development cycle in self-storage ever. It is blown everything prior out of the water. Every single year, development is 2, 3, and 4 times higher than the next highest average year prior. Retail and other asset classes like residential real-estate prior to 2008 went through a 10-year development cycle. Banks didn't like to lend to people to develop self-storage. So, self-storage didn't really go through a development boom. Today it is.
So, what that means is that in 2008 when customers needed to use self-storage, there weren’t as many options as there are today. So, you could still get somebody in, still fill them up, and then eventually charge the rate. Today that is very different. You probably noticed there’s a self-storage facility on every single landscape.
So, in the event of a credit contraction or a major recession (not a Covid recession where the government just pays for everything), I think it'll look very different.
First, there's supply everywhere in self-storage right now in every single market. Debt structures are different. We have short-term financing. We have funds…a lot of money got involved and it created a development boom. We also had – simultaneously due to super-low interest rates and people now being able to get into the homes and move around combined with the Internet and COVID coming in and decentralizing the workforce through office space – a demand spike.
So, all these things are happening with self-storage it was the perfect storm. It was amazing. I would never underwrite or expect the last five years to happen that way. It won't. Yet, a lot of people are buying assets as if it will. They think that this huge uptick is going to continue forever. That's not how works.
After 2008, institutional money came in, third-party managers came in, we got favorable loans, and we could develop more which created a massive boom. If 2008 happened again today it would be completely different. We have supply on the market (which a lot of markets are oversupplied), we are artificially lifted up through COVID, we have totally different banking structures, and new inventory through development coming on everywhere. Yet, the cost of materials to put the product out of the ground is three times what it was just five years ago, so they can't sustain a massive cushion.
Okay. Now that I've gone through all of this, you’ve seen the development trends, you've seen everything else, you say,
“Holy cow, AJ! Does this mean self-storage is over?”
No, absolutely not. I'm buying, I'm building, and I am bullish on self-storage. The economic forces around self-storage are better than any other asset class. With that said though, the performance from the past will not dictate performance in the future. We have more danger in self-storage than it's ever had ever in this asset’s life hands down. I also think it provides a better opportunity for any individual to get into this asset than any other commercial asset. There are still tons of mom and pops to buy. There are tons of ignored markets. When looking at self-storage, and the risk and self-storage, oversupply, and not being able to survive an actual credit crunch. We have turnover. We move. If the housing markets freeze, you have a seasonal outflow that you won't get in an inflow to the next year. That goes two years in a row. You are now 15 to 20 percent down in occupancy. Plus, you have a compression of all other lines of revenue. That they just evaporate away. So, your overall revenue goes down dramatically. Can you cushion that? How will you offset it? The best way to prepare yourself and to make sure none of that happens is to go to markets where demand is super high and there's no new inventory on the market. Because then if there's a crunch, customers have nowhere to go, so they still have to use you. You're going to lose the ones that just leave the market for good. But anyone that needs storage will have to utilize you so you can remain at high occupancy.
So, is self-storage a risky investment? That’s the thing you came here to find out…the first thing