Feast Or Famine?

Posted by msmessenger on Apr 1, 2016 12:00:00 AM

Supplying Storage To A Hungry Nation

There’s no denying that 2015 was a remarkable, record-setting year for the self-storage industry. As a matter of fact, many storage professionals have even called it the “best” year to date for the once overlooked asset class. Yet, while the stars were in perfect alignment for stellar performance, as a whole, the industry didn’t experience nearly as much new development as was anticipated.

Dean Jernigan, CEO of Jernigan Capital, a commercial real estate finance company that provides financing to private developers, owners, and operators of self-storage facilities, notes that only between 150 and 175 storage properties were built in 2015—meaning construction was completed and the facility was open for leasing. This was, however, nowhere near the amount that needed to be built in the top 50 markets to ease pent-up demand and match the nation’s ever-increasing population.

“My estimate is that based on population growth alone and just looking at the top 50 markets, we need about 375 new properties per year to satisfy the demand in those 50 markets,” says Jernigan, who notes that over the next five years, approximately 1,900 facilities needed to be built in the top 50 markets just to keep up with population growth. He predicts that only 300 to 350 properties will come on line with the certificate of occupancy obtained in 2016. Nevertheless, he is optimistic that this development cycle will be different than previous cycles.

“We are in the second year of the development cycle,” says Jernigan, who explains that past cycles have been 10 years, with three years of development and seven years of acquisition. “And it may last longer than previous ones. If there isn’t another ‘Black Swan’ event, it may last five or six years due to demand.”

A Black Swan event is an outlier, as it lies outside the realm of regular expectations; nothing in the past can convincingly point to its possibility. In addition, a Black Swan event carries an extreme impact. The World Trade Center terrorist attack on September 11, 2001, is an example of a Black Swan event.

Starved For Storage
While there are many “pockets of opportunity” across the country, some markets with rapidly growing populations and development restrictions are clearly experiencing a storage shortage—Washington, D.C., Manhattan, and Boston as prime examples according to Jernigan. “These markets have high barriers to entry, long entitlement processes, and high land costs,” he says, which makes them extremely ripe for additional self-storage. In addition, he believes that the markets that have attracted Millennials—the approximately 95 million Americans born between 1982 and 2003—such as Nashville, Tenn.; Charlotte, N.C.; Seattle, Wash.; and the secondary markets of Austin, have a great propensity for growth in regards to self-storage.     

When it comes to population, however, California is still king with 38.8 million residents. And despite the fact that California has approximately 5,500 self-storage facilities, H. Michael Schwartz, Strategic Storage Trust, Inc.’s president, CEO, and chairman of the board of directors, feels that Southern California and the Bay Area have the space for more storage.

“There is lots of population growth,” Schwartz says. “And facilities can still be successful even with competition. But be aware that new supply is coming.” Additionally, Schwartz, whose company has been focusing its buying and developing efforts to Toronto, Ont., remarks that this particular Canadian market “still has a supply deficiency.”

Although new competition may be the main concern of operators who are currently enjoying higher occupancies and improved rental rates, it may be hasty to switch to panic mode right now. In fact, Jernigan predicts that the industry’s heightened performance will continue for roughly two more years. “There will be more competition, of course, but mostly in 2018,” he says. “How will we perform then? I think we will keep our wits and not start price wars. Storage is a strong platform. We won’t need to reduce rates to compete.”

Aaron Swerdlin, executive managing director of NGKF Capital Markets, agrees that the industry has plenty of room for additional storage facilities. In fact, he foresees between 300 and 400 new self-storage facilities being built each year for the next three to five years—an amount that he calls both “manageable” and “very absorbable”.

“Given that self storage is such a localized business, I don’t think there is an MSA in the country that categorically will be overbuilt—at least not in the next several years,” says Swerdlin. “I think there are submarkets within MSAs that will experience some supply/demand stress; but the stresses will be localized and not widespread enough to bring down an entire market like Atlanta, Phoenix, or Vegas, that we experienced in the 2008-2010 cycle.”

Swerdlin goes on to say, “Self-storage is gaining acceptability and demand is up. There is lots of capacity to build new supply as the industry will be underserved for the next three to five years.”

Heating Up
Despite the fact that demand is certainly up, there are some markets that have begun to heat up over the past year with ample amounts of new facilities in the planning or development stages. For example, Florida and Texas are once again experiencing building booms.

Swerdlin has heard about a lot of facilities under development in South Florida, but isn’t concerned with market saturation. “The residential market is growing there,” he says, adding that numerous condominiums and non-vacation homes are currently under construction as well.

In regards to Texas, Rachel Parham, president of Bulverde, Texas-based Noah’s Ark Development, has first-hand experience with the increased development activity, noting that the uptick has also led to stricter building codes and more stringent HOA guidelines for self-storage in several areas.

“It depends on the area, but the secondary markets that are becoming primary markets have the potential for both growth and overbuilding,” Parham says. To be a little more specific, Parham states that several suburban Dallas markets, including Plano and Irving, are becoming primary markets. “There are formerly rural markets that are becoming secondary markets,” adds Parham. “That’s where it’s going to get scary.”

Speaking of Texas, Austin is a market with copious storage projects in the works. According to Eric Kaplan, senior vice president of business development at Advantage Storage, “every corner” of Austin seems to have a coming-soon sign for a self-storage facility. Kaplan also includes Atlanta, Dallas, and the outskirts of Nashville on his list of markets that currently have numerous new facilities in either the planning or development stages. 

Although the barriers to entry are reasonably high and there’s new housing being built, Denver, Colo., is another market that Parham finds troubling. Her uncertainty for Denver is primarily due to the fact that a majority of the new houses are vacation homes. “The owners aren’t going to use self-storage as much, so it’s a touchy market.”

Jernigan is wary of the smaller markets as well. While he acknowledges that some of markets such as Savannah, Ga., and Charleston, S.C., are very appealing, their need for self-storage may end up being pretty shallow. “The tertiary markets aren’t as deep,” says Jernigan. “Be careful about diving in.”

In addition to traditional self-storage, RV and boat storage development is on the rise too. According to Caesar Wright, president of Mako Steel, the Pacific Northwest is a hot area. “There are lots of new RV and boat facilities being built in Washington and Oregon,” he says, adding that the Portland market is particularly strong. Of the RV/boat facilities being built, Wright asserts that about 70 percent is enclosed storage; the remaining 30 percent is canopy-style storage spaces.

Boiling Over?

Of course, oversupplied is the other aspect to the supply scale. While Kaplan believes that Dallas, Houston, and Las Vegas may be most susceptible to overbuilding, there were far less straightforward examples when discussing the markets with the greatest potential for becoming overbuilt. Even though Jernigan listed Atlanta, Phoenix, Denver, Dallas, and Houston as the “usual suspects”, he isn’t as concerned about market saturation as others within the industry. “There’s no market right now with too many facilities in development to cause alarm,” he says.

Basically, as Swerdlin also suggests, the markets and submarkets with the utmost potential for saturation are those with low barriers to entry and easy entitlement processes. “Self-storage is a two-to-three-mile radius business,” says Swerdlin. “The areas where it’s easy to develop and land is cheap should be avoided. Don’t worry about in-fill locations.” He goes on to say that suburban markets are very “mobility dependent.”

Furthermore, Swerdlin advises storage developers to “get a real grasp on what’s happening in a market” before deciding to build. “Stay away from markets that have a lot people who don’t know what they’re doing,” he says. “They’re the ones who will end up screwing things up.”

Watch The Pot

There is an old adage that suggests a watched pot never boils. Although it typically applies to situations that require patience, perhaps it’s applicable advice for avoiding market saturation within the self-storage industry. As a matter of fact, many storage veterans are confident that overbuilding can be circumvented if every developer closely watches the amount of new storage supply coming on line with a keen eye.

Nowadays, that is easier to do than ever before thanks to more readily available information. For instance, STR, Inc., a company that provides competitive benchmarking, information services, and research for the hotel industry, recently began collecting development activity data for the self-storage industry.

“Tracking the volume of new self-storage supply entering a market will enable developers and operators to better allocate new supply so that markets do not become oversaturated, resulting in better performance for all operators in the industry,” says Anne Hawkins, executive vice president at STR, who adds that knowing how much storage is in the pipeline will become an important part of the equation.

Jernigan completely agrees, offering his full support of STR’s initiative. “Transparency with new supply entering the industry will help predict when too much development can trigger a downturn in the performance of a certain market or the industry overall,” he says. “STR’s database will help operators, developers, and financing partners make smarter decisions on where and when to build.”

Jernigan is adamant that this venture can limit overbuilding, enabling developers to “build smarter” this time around. “Lack of information results in overbuilding,” he says. “We have a much better chance to control overbuilding with this.”

According to Hawkins, the high-level report, which will likely be available on a quarterly basis, will include information about how much supply is in the market, how much new supply is coming on line, and the new supply’s current stage of development, as well as where and when the new facilities will open. In addition, the report will be available as a general analysis or broken down by geographic area and stage of development.

Moreover, other companies—such as NGKF Capital Markets, which partners with MiniCo on the annual Self-Storage Almanac—are taking it upon themselves to provide the industry with information that can potentially prevent overbuilding during the current development cycle. Swerdlin states that NGKF Capital Markets has supply and demand data available by market for the top 20 MSAs. Its data looks at supply and demand from an urban versus suburban standpoint to put the supply/demand equilibrium into question.

“No one is anchoring to those numbers anymore,” says Swerdlin. “It’s not just five square feet per person. There are dense markets with long staying residents that have lots of potential. It’s a new phenomenon. Developers are finally starting to look at it per location versus industry wide.”

Mindful Morsels

Besides staying on top of new development, the industry professionals interviewed for this article had wide range of relevant advice for storage developers. For starters, no one could over emphasize the need for feasibility studies and ample due diligence.

“Hire a professional,” says Parham, “and a good developer. Hire people who are going to tell you the truth. You don’t want to be stuck with a lemon, so do your homework.”

Wright is on the same page as Parham. “It’s Business 101. You have to get feasibility studies done,” he says. “Do your due diligence and homework. Ask yourself if the area can support what you want to build.”

With due diligence in mind, both Wright and Parham stress the importance of gauging the area’s receptiveness of your proposed project prior to spending thousands of dollars on building plans and land.

“Make sure the municipality is on board,” says Wright. “City municipalities are being more stringent, especially about curb appeal.” He notes that some planning and zoning committees have very specific requirements, such as stucco or block exterior, that can dramatically affect the costs of a project.

Parham explains that stricter building parameters are becoming a more prevalent problem throughout Texas, with home owners associations requiring masonry instead of steel for self-storage projects. “The stipulations and codes are off the board,” she says. “HOAs and corridors are making it very difficult to build [storage] in Dallas and Austin. They can trump the city’s rulings. There are areas that need storage, but communities outside the cities have hard requirements.”  

While land considerations are included in the due diligence process, Jernigan reminds every developer to take a detailed analysis of the soil prior to purchase. “Pay close attention to the dirt,” he says, mentioning that soil contamination and consistency can make projects impractical or even impossible. Indeed, the costs associated with site remediation and/or soil compaction have kept plenty of potential facilities from becoming realities.

Continuing with the topic of land, a relatively new trend is to purchase smaller parcels to house multistory self-storage projects, whereas, previously, a one- or two-acre lot would have been considered unsuitable for traditional, single-story storage buildings. Although cutting down on acreage is a sound practice from a financial point of view, developers should be aware that vertical buildings are not a good fit for every market. “You don’t want to overpay on land,” says Kaplan, “but developers are buying smaller land parcels and building up—even in suburban areas where it may not work. Be very careful where you build them.”

Then, once all your development ducks are finally in a row, be prepared to wait. “There is a large amount of activity going on and companies are busy,” says Wright. “It may take longer than anticipated to get a project finished. Be patient from start to finish.”

At the end of the day, the self-storage industry can expect at least two things to occur during this development cycle: supply will surge and understanding will increase. “There’s no question that there will be more facilities built in 2016 than last year and more in 2017 than 2016,” Schwartz says. “We can’t stop people from developing, so we have to be good at what we do. Make sure you’re developing high-quality product in retail areas with good demographics.”

Schwartz adds, “Everyone has money and everyone has debt for self-storage. It was a sleepy asset class, but now it’s part of the core due to increased understanding.”

Erica Shatzer is the editor of Mini-Storage Messenger, Self-Storage Now!, and Self-Storage Canada.