Danger Zone!
Overbuilding Is Happening Now
Imagine yourself as a dinner party guest 25 years ago, and the following questions had been posed:
Who won the 1968 Masters? Do you know which Darrin Stephens appeared first on Bewitched? Dick Sargent or Dick York?
Unless you had been fortunate enough to have someone at the table who could spout off Bob Goalby and Dick York, chances are the only sources for that information would have been at the local public library or a set of encyclopedias that may or may not have existed at your host’s home. By contrast, in 2017 chances are any of the dinner guests would have the answers to both of these questions within seconds.
Our computers, smart phones, and tablets have changed the world. They provide us instant access to almost any fact we could ever want. And this isn’t just limited to useless trivia about golf or 1960s television. The data we can find on the Internet leads us to smarter and better informed decisions, cures for medical conditions, seamless global commercial transactions, and so much more.
Now, you may be thinking, “I get it. The Internet is great, and we have access to more information in seconds than our grandparents could’ve obtained in years. So what?”
We are in the midst of a self-storage development cycle that is unlike any other the sector has ever seen. We have played catch up for the past two years to make up for the square footage that was not built during the Great Recession and for four years thereafter. The demand for storage in major cities across the country has never been higher than it was in 2014, and commercial real estate developers, being the entrepreneurial lot they are, quickly figured out that self-storage development was their most promising opportunity over the next four years.
Jernigan Capital (JCAP) was created as a knowledgeable, creative, and value-added source of capital to developers who wanted to ride the self-storage development wave. JCAP’s founder, self-storage veteran Dean Jernigan, as early as 2013, saw the merger of (1) high demand resulting from population growth and a shift away from single family to multifamily housing, (2) low supply brought about by the Great Recession, and (3) a bank regulatory environment that was unlikely to provide sufficient capital to fund needed new supply.
Two years and roughly $300 million in capital investments later, Dean Jernigan and Jernigan Capital can claim they were right about the opportunity to develop, but they can also see places where overheating is a risk. Major markets like Dallas and Austin are at the tipping point of saturation. And others like Denver, Miami, Houston, Atlanta, Nashville, and Charlotte, are worth watching. Given the fact that the development cycle is now at its peak, having good data has become an absolutely crucial element to successful site selection. Whether you’re a developer, operator, lender, or investor, reliable information regarding current supply, new developments, and rate trends should be of utmost importance to you.
In past development cycles when good data was not plentiful, our sector would stop development only when rental rates softened and occupancies declined, which was invariably too late. This often resulted in crash landings, marked by price wars and substantial oversupply that affected overbuilt markets for years. Development was largely guesswork based on sketchy information or, in the worst case, no information at all.
However, to tie this back to the dinner party analogy above, today our sector has a large amount of information at our fingertips that can help us navigate a soft landing and ensure that the self-storage sector achieves real estate industry-leading returns after the development cycle ends. Several well-known research and data companies serving the real estate industry are devoting significant resources to building online databases of current supply figures and pipeline reports of new supply, including unconfirmed, in planning, and under construction projects. These companies—REIS, STR, and Yardi— are scouring the Internet, building department filings, city planning commission proceedings, and using data provided by storage professionals all over the country to provide high-quality data that will help the self-storage industry as a whole.
Utilizing Data
It is critical that the self-storage sector use the data supplied by these companies, as well as all other relevant data, to properly manage the supply of self-storage. The release of reliable supply and pipeline information is a major milestone for our sector, maybe the biggest in over 30 years. The sector will now have the proper information to thrive continuously instead of waiting for downturns to self-correct. Developers should utilize this data before acquiring land and beginning construction in order to avoid the “lose/lose” situation of new projects being located too close together. Capital providers should also use this data. Proper use of this data by each party in the chain—developer, operator/manager, and financing source—provides a system of checks and balances that can minimize crucial mistakes that hurt the entire sector.
Jernigan Capital has invested hundreds of man hours working with data providers, so we have as much information as possible while making our investment decisions. As a lender and partner in all our projects, Jernigan Capital uses a surgical approach to site selection. We evaluate large amounts of available data each time we review a prospective self-storage investment, focusing on the nuances of each submarket. If a developer brings us a great site but two new facilities are under construction within two miles, we can’t assume it will perform as well as we hope it will. We underwrite deals differently based on this data (lower rates, higher lease-up times, etc.) or we even might pass on deals altogether. We believe the entire sector should evaluate projects in the same way. Just because a site is zoned correctly and looks to be profitable doesn’t mean that a self-storage facility should be built there.
We strongly encourage all participants in the self-storage sector to move to a data-driven process of evaluating investments in self-storage projects. Anyone reading this article should contact these data providers to learn about their platforms, should attend their webinars, and should begin using their online resources immediately.
Becoming data driven will require participants to become acquainted with the stages that characterize potential new storage facilities. There is a big difference between a facility that is being considered compared to one that is under construction. Lumping all potential new supply into one big category results in market miscalculations; therefore, it is critical that the sector speak a common language as we refer to new projects. In the sidebar on this page, you will find some terminology that Jernigan Capital and STR Global believe accurately describe the various stages of development.
To provide additional substance to these terms, the research done by STR and Jernigan Capital indicates that about 50 percent of “unconfirmed” sites ultimately are constructed. Facilities that are in “planning” are completed about 75 percent of the time, while facilities in “final planning” are completed about 90 percent of the time. Once a facility is “in construction,” it is going to open nearly 100 percent of the time. As you begin to dig into the different data sources, we urge you to stay up to date on where projects stand in your markets.
The Danger Zones
In addition to all the insight and instruction above, Jernigan Capital is beginning to advise the sector on certain markets that need to be watched closely or even be avoided. If you follow Dean Jernigan on Twitter (@deanjernigan), you might have seen these cities discussed. Or if you heard him speak at the SSA Fall Conference in Las Vegas, you got an in-depth case study on the Dallas-Fort Worth Metroplex. While we at Jernigan Capital are highly focused on the data in these markets, we strongly encourage you to do your own research as well.
Dean Jernigan has developed two categories of markets that data suggest could be at risk for overbuilding. The first category he has coined as the “danger zone”; the second is simply a “watch list”. We place markets in the “danger zone” when new supply, computed using the data analyses described above, exceeds 10 percent of the total current supply. We have determined that Dallas-Fort Worth and Austin fall in the “danger zone” threshold. Jernigan Capital will no longer consider any new investments in these markets. There is just too much going on there to believe another new project would be successful.
There will be a point, due to population growth, that these markets become viable again for new supply, but, as it stands now, so much supply is coming on line in the next year that it will be tough for a market to absorb all of it at once. The landings here could be a little rocky, so by using this data we can attempt to prevent that as much as we can.
In addition to the “danger zone” markets, Jernigan Capital would consider certain submarkets in Dade and Broward Counties within South Florida (Miami/Hollywood/Ft. Lauderdale) to be potentially dangerous. While storage supply in South Florida was very low before the development cycle began, there is enough self-storage development underway in certain submarkets that those areas might have difficulty leasing up all new projects in development. We believe these counties will be fine in the long run, but they might have some short-term bumpiness.
Also of note is the Denver MSA. JCAP is awaiting more concrete data for Denver, but there is a great deal of development going on in this market. We are monitoring it very closely, and the amount of new square footage is concerning to us. The data we have at the moment is not enough for us to move it into the “danger zone,” but as we compile more information we will be able give a more precise read on this market.
As of now, we will leave Miami and Denver on the “watch list”. However, we encourage you to do very in-depth due diligence of these markets if you are considering a project there.
The “watch list” markets are those indicating an increase by five percent or more of current supply. These markets should be carefully monitored. There is still room in these markets for new projects, but, as 2017 continues, these could potentially be moved into the “danger zone”. Watch List markets at this time include:
- Denver
- Miami
- Houston
- San Antonio
- Nashville
- Charlotte
- Atlanta
- Phoenix
- San Jose
In these areas, it is critical for developers to understand the intricacies of submarkets. While the market as a whole might be OK, certain submarkets might be heading towards being overbuilt. Because of the detail these new data resources can provide, you should be able to see exactly what is going on in specific submarkets. These companies can provide exact addresses of new projects, so you can easily identify smaller trade markets that could become overbuilt.
Jernigan Capital is constantly collecting new data, and we plan to be very vocal in sharing our views on new supply. This is what’s best for the sector. We ask that you as developers, operators, lenders, and investors do the same. The more information we share with one another, the softer the landing will be for everyone when the development cycle comes to an end.
Jernigan Capital is optimistic about the future of our sector and the ultimate success of this development cycle. There is still a need for new storage in major markets across the country. But, as we enter the home stretch, we as a sector must be more careful as we consider new projects. We do not want to see rates and occupancies crash. With the new resources discussed above and thanks to the hard work of these data providers, we don’t have to experience that. The sector can work together, share information, build smart, and enjoy a profitable ending to what we will look back on as a great time of self-storage development.
We encourage you to reach out to MiniCo and the companies discussed earlier, and invest time and money to increase your knowledge.
Warner Russell is the manager of business development for Jernigan Capital.
With contributions from John Good, president and COO of Jernigan Capital.
More Content
Popular Posts
The self storage industry is in a precarious...
The REITs new pricing strategy – lowering...
With the approval of both companies’...
There are an estimated 700,000 hotels in the...
Boat and RV storage has morphed and...
In a booming economy, expendable income...
It’s said that necessity is the mother of...
National Storage Affiliates Trust (NSA), the...
Recent Posts
Mother Nature can be a cruel mistress....
Anyone who has developed any type of real...
Fall is in the air, pumpkin spice is in your...
Self Storage Association (SSA) President and...
If you have a self-storage facility, odds...
White Label Storage is a third-party...
The self-storage industry has drastically...