Data Mining Tools Matter

Posted by Poppy Behrens on Feb 1, 2018 12:00:00 AM

The Importance Of Tracking Supply And Demand Trends During A Storage Expansion Cycle

The self-storage real estate sector operates amidst a building boom that many fear could lead to oversupplied areas in the years ahead, resulting in declining rates and occupancy not seen since the Great Recession. Some experts say this trend can be seen in some metro areas today.

Given the reality of the current development cycle, owners, operators, developers, and investors must double down on their due diligence when planning future facilities, lest they face the prospect of repeating history.

Self-storage has long been shrouded in mystery when it comes to accurately measuring the number of new facilities as well as those in the development pipeline.

Now there are technology tools coming on line that zero in on specific submarkets to better gauge storage supply and demand, the amount of building activity occurring, and the planned facilities that will come to fruition. Plus, these applications can unearth a rich source of data that can be leveraged at the operational level daily.

These data mining tools may become a critical component in all due diligence efforts going forward, and could be key to minimizing oversupplied areas.

But how accurate is data mining technology, and how useful is it in planning efforts?

Self-Storage Supply

What impact will new supply play over the next several years for the self-storage industry? The current rate of new development indicates the effect will be substantial. Self-storage development has been trending upward since 2014, with many expecting a building peak later this year.

A year ago, Jernigan Capital, a real estate investment trust in Memphis, Tenn., estimated approximately 600 new facilities were delivered nationwide in 2016 and that 2017 could go as high as 900 facilities before likely declining in 2018. However, in the subsequent months, some industry experts predicted 2018 would see continued strong development, possibly exceeding 2017 development.

Charles Byerly, president of Irvine, Calif.-based Westport Properties, confirms that 2016 and 2017 were big for self-storage building, with little sign of slowing. “I think ’18 and ’19 will follow suit,” he says. “I would say we’re peaking in this cycle in terms of the number that are coming online.”

David Dent, Yardi senior real estate market analyst in Centennial, Colo., believes the storage sector is in the middle of peak completion levels for the current real estate cycle and should soon begin to see decreasing completions of new stores.

“Interest in storage development surged in 2016 with permits peaking in Q4 2016,” Dent says. “Following this peak in permits, new storage starts peaked in spring 2017, and completions are likely hitting peak deliveries between fall 2017 and spring 2018.”

However, Union Realtime, a New York data technology firm, examined storage construction spending and concludes there is a dramatic increase in supply coming in the years ahead.

Union Realtime notes that between January and September 2017, the rate of self-storage supply constructed had increased by 79 percent over a nine-month period. With the pace of construction increasing at that clip throughout 2017, it is likely that the total number of facilities that are slated for delivery in 2018 will be substantially higher than those opened last year.

“That is a function of incentives in the industry of building versus buying,” says Cory Sylvester, Union Realtime principal. “If I can build at $100 a square foot, and if people are buying existing facilities at $200 a square foot, as a developer, I am highly incentivized to build a new facility. Until that dynamic goes away or until people start seeing fundamentals soften considerably, people will continue to build new facilities. We don’t see building slowing down until there’s a change in that incentive structure.”

Other industry data miners are looking at their numbers and drawing similar conclusions. “Do we think development is slowing down? We haven’t seen that yet,” says Anne Hawkins, executive vice president for STR, a leading provider of data and analytics in Nashville. “We will be interested to see how many of the projects in the development pipeline actually open. All projects in the development pipeline will not end up coming online.”

Data Mining Storage Solutions

Many industry professionals fear overbuilding will lead to excessive competition in many markets. Oversupplied areas inevitably lead to declining rental rates and excessive concessions such as months of free rent. The industry saw the effects of this trend during the Great Recession.

Union Realtime, Yardi, STR, and others have developed technology tools that pinpoint supply and demand activity in submarkets from coast to coast. The programs examine building activity, occupancy, rental rate trends, and other economic and demographic factors. These industry services regularly update the data to present their clients with instant snapshots of supply levels and economic activity in given markets.

Data miners employ several factors to build their supply and demand databases, but job growth and migration are favorite targets.

“In terms of how to track demand, we think the most critical and timely indicator you can look at to understand the directionality of demand is the trend in nonfarm payroll growth, essentially how many jobs are being added in your area and how that rate of job growth is changing,” says Sylvester. “The rate of change of job growth gives you the best indication of whether demand is increasing or decreasing. Our platform tracks job growth in local areas.”

Yardi Matrix Self Storage factors in two primary drivers of storage. “Approximately half of new storage projects are driven by local population growth due to migration for jobs or retirees attracted to the area,” Dent says.

For example, in Denver, where new store development is red hot, storage demand is predicated on the long-term wave of millennials coming into the area. In addition, smaller retiree markets such as Charleston, S.C., are adding storage to accommodate retiring baby boomers.

“The other half of new stores are additions to replace and upgrade current completed inventory,” Dent adds. “New stores are being added in markets like Brooklyn where substantial multifamily completions need to be followed by local additions of storage to accommodate residents.”

The Yardi Matrix Self Storage team gathers this information through research to compile a picture of the urban U.S. landscape covering over 80 percent of the country’s population. The Yardi Matrix platform features data and analytics that are updated and compiled for 133 markets in the 100 top U.S. metros. The data suite includes monthly rents and rent growth; transaction volume and deal pricing detailed monthly by metro and featuring store count, transaction value, and price per square foot; and loan data at the property level.

New supply pipeline data includes monthly construction starts by metro as well as the current development pipeline of all stores under construction. Dent says new supply data is updated daily and all stores under construction are contacted every 30 days to update their status. There are nearly 2,000 developments in the new supply pipeline, all of which have been independently confirmed by team members who are in regular contact with more than 5,000 municipalities, planning commissions, and zoning boards.

STR tracks supply and demand by asking self-storage operators to provide data from their property management systems on a monthly basis.

“We calculate supply and demand by net rentable square footage available versus net rentable square footage rented or occupied, and we chart the change in supply versus the change in demand over time,” Hawkins reports. “We start by examining data at an MSA or market level, but it’s at the more granular submarket level where we see dramatic differences.”

Population Versus Migration

According to the 2018 Self-Storage Almanac, the industry is now navigating through one of the largest oversupply periods in its history. Tracking migration, as opposed to population growth (birth rates, mortality rates, immigration), will lead to a better understanding of what direction self-storage demand is headed in any given area.

“The industry has long focused on population growth as the most important indicator of demand,” Sylvester says. “Population growth doesn’t vary much from year to year for the most part, yet demand fluctuates dramatically. What drives self-storage demand? The primary driver is migration, and the most significant driver of migration is job growth, which is why you should focus on jobs when evaluating the prospects for self-storage demand.”

Nashville is often cited by storage professionals as a city with overheated development. “We believe that supply growth in Nashville is largely driven by population and job growth—the city is growing by 100 people a day and has seen corporations move into the area,” Hawkins notes. “It is tough to look at any one metric—operating facilities, development projects, or performance—in a vacuum, but I would expect that Nashville will demonstrate greater growth in supply than in demand in the future.”

In areas with considerable storage development occurring such as in Nashville and parts of Texas, new population coming into these communities can potentially reduce the negative effects of new supply, however, that doesn’t mean a substantial number of new residents are going to seek out storage.

“In Nashville, we are tracking approximately 300 operating facilities and over 100 development projects. By contrast, in Dallas there are over 1,000 operating facilities, and we’re tracking 156 projects,” Hawkins reports. “If the population is expected to grow at five percent, that means there should be theoretically less dramatic impact on the city. Nashville is booming, but if the entire pipeline were to open, to use a dramatic example, and supply were to increase 30-plus percent, could Nashville support that? I don’t think so, despite the dramatic growth in city.”

Hawkins says STR has focused on Texas, where supply is exceeding demand in certain areas. During the past 12 months, Dallas, along with Denver, Miami, and Nashville, have consistently had the highest count of nationwide development projects.

Dent says the most active development markets include fast-growing secondary cities such as Austin, Denver, Portland, Nashville, Raleigh, Charlotte, and Miami.

In some markets, the level of development vastly exceeds near-term demand for self-storage, according to Union Realtime’s Sylvester. “You see that in Texas, where barriers to entry are lower in terms of permitting and zoning,” he says. “You’re going to start seeing this in Nashville, Denver, and North Carolina, just to name a few. New developments are beginning to open, and you see renal rates in those markets becoming weaker.”

Fears Of Falling Rents

The overriding fear of over-expansion of self-storage is the ultimate effect on rental rates. According to several sources, rates have dropped in a number of metro areas experiencing robust construction activity.

A Q3 2017 industry report by Tampa, Fla.-based Skyview Advisors notes that overall top line revenue growth continues its deceleration. “Demand remains soft in many markets, and new supply continues to have a negative impact on pricing power and occupancy trends,” Skyview reports.

Some REITs have noted higher than anticipated incentives and increased internet marketing expenses due to the pressure of new supply. “There is a continued focus on discounts as a necessary means to maintain and drive occupancy,” the report says.

Sylvester says street rates in Houston were down 30 percent year-over-year before Hurricane Harvey. That’s a function of both oversupply and slowing demand.

“It’s an example of what can happen when a market reaches a certain tipping point in terms of oversupply,” Sylvester warns. “You see some significant rate weakness in some of the biggest markets across the country, and we expect that to continue in 2018.”

As of December, Dallas, Chicago, Denver, Austin, Baltimore, and Washington, D.C., saw rental rates decline five to 10 percent versus the prior year, according to Union Realtime data. “You’re seeing regions that have a lot of supply under construction, and this rental rate weakness will likely continue for several years as more facilities come to market,” Sylvester says.

Yardi Matrix identified weak rent growth in cities tied to the energy business such as Houston, Austin, New Orleans, Oklahoma City, Fort Worth, and Tulsa. In addition, fast growing cities facing medium-term new supply pressure (Denver, Portland, Raleigh, Charlotte, and Richmond) showed weakness.

Dent adds that rent growth is strong in markets with high barriers to storage development, such as California and Seattle, as well as fast growing tertiary markets like Augusta, Boise, and Colorado Springs, where baby boomers are retiring, and developers have been slow to add new stores.

Longer Lease-Ups

Declining rents, coupled with the potential for falling occupancies, create challenges for newly opened facilities in the lease-up phase. Sylvester says it now takes a facility three-plus years to fill up. “With extending lease-up periods, supply is a compounding problem, because facilities that opened in 2017 will still be impacting the market in 2020,” Sylvester says. “We’re going to continue to face increasing supply pressures over the next couple of years.”

Byerly generally agrees on the longer lease-up periods in certain markets. “As new supply is coming on line in Denver, Austin, Miami, and Dallas, as those submarkets are getting hit with multiple new properties, that’s going to slow lease-up times,” Byerly says.

However, Byerly is seeing properties in certain submarkets achieve stabilization in 18 to 24 months.

Once properties become stabilized, many of the rules change. As STR examines the data collected, Hawkins says she is impressed by the resilience of stabilized facilities.

“In most instances, we are seeing operators able to push through rate increases despite occupancy declines,” Hawkins says. “The concern is when certain operators see occupancy decline, they drop rates to drive move-ins, and this can cause downward pressure on performance.”

Not A Panacea

As the data miners dig deep into storage analytics, supply and demand characteristics reveal themselves as never before. But no data service is perfect, and they need to be evaluated on their benefits to individual operators.

“What I would caution is that I don’t think any of the data miners are quite there yet in terms of the tool and having a full picture,” Byerly says. “What’s lacking is precision and accuracy.”

He says some services rely on Standard Industrial Classification (SIC) codes, which are too broad for self-storage since they include warehousing, cold storage, and other categories. Also, developers sometimes file reports on the progress of projects that won’t see the light of day.

“There’s a lot of duplicity in efforts, so some sites in macro markets get counted more than once,” Byerly notes.

Data mining services are important new tools to employ in due diligence work, but Byerly insists they must be complemented by old-school methods of boots on the ground, talking to city planning authorities, and working with local real estate brokers in surrounding micro markets and submarkets that may overlap the radius of a proposed store.

Byerly adds that Google Earth has been a game-changer in recent years to track existing supply and look at a city’s layout where a proposed store might draw customers.

“I think data mining services are getting better,” Byerly says. “It’s certainly a good box to check and maybe crosscheck to see that you didn’t miss anything or there’s something out there you need to investigate further. They’re certainly another add-on, but there’s not a data mining service out there you can use and base my site selection on specifically.”

David Lucas is a freelance editor based in Phoenix, Arizona. He is a regular contributor to all of MiniCo’s publications.