Markets On The Move: Arizona

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

With 36 sales through the end of November 2015, sales velocity in Arizona continues to be strong. In fact, the number of closed transactions that took place in the past three years exceeds the number sold in the preceding seven years combined. Take note, however, that this year’s numbers include the 12-property Security Plus portfolio. This activity paints a picture of a very strong market, raising the question, “How much longer can this go on?”

As shown on the Table 1, cap rates appear to be continuing their downward compression, moving from an average of 6.47 percent in 2014 to 5.95 percent this year. The cost per foot of sold properties verifies this growth in value, with an average of $63.75 in 2014 increasing to $72.96 this year. Note that a correct understanding of the cap rates cited for each year in Table “A” requires an underwriting formula that includes each year’s respective occupancy percentage and each year’s respective aggregate operating expense amount.

Not surprisingly, when you look at the numbers behind the numbers, there continues to be two distinct markets for storage investment: The Class-A and B+ market and also the market for the older, lower-quality assets that are of lesser interest to REITs and other institutional owners. If appropriately underwritten and effectively marketed, Class-A properties can achieve sub-5.5 percent cap rates and prices per foot in the area of $150. The older, non-institutional quality assets are trading at six percent caps and prices per foot in a very broad range from $30 to approximately $80. The major determining factor of price per foot is the level of market rents in each specific property’s own sub-market location.

If I were to look into my crystal ball to predict what conditions might be in next year and the year after that, it would be important to know what was in the development pipeline. There is no doubt that self-storage development is extremely hot. In fact, at least 35 new projects either opened in 2015 or will open early this year. These projects will add more than 2.5 million square feet to our current supply of almost 18 million square feet, which is a 15 percent increase. This new construction will satisfy the storage needs of about three million people. Is that much really needed or might this indicate the start of another over-built market in Arizona’s long history of dramatic real estate cycles? One can’t know for sure, but a look at Arizona’s growth in population may give an indication.

The answer there indicates that while it isn’t the boom times of the last decade, population is growing. A new report from the census bureau showed the state’s population grew by more than 1.4 percent in the past year alone. Although that’s less than half the rate at which Arizona was growing a decade ago when it led the country, it is still good enough to rank Arizona as number nine nationally. The current rate of growth means that population grew in 2014 from 6,828,065 to 7,828,783. What’s really driving the population growth in Arizona is that, even with the economy still in the doldrums, people are still moving here from elsewhere; at least 100,000 people did so in 2014.

As would be expected, growth is occurring at a higher rate in some areas of the state than others. The fastest growing areas are the southeast portion of Maricopa County, which includes Gilbert and Queen Creek. This area grew at a rate of seven percent. That was followed by the southwest portion of the county which grew at 4.1 percent. Interestingly, the Town of Maricopa posted a 3.6 percent increase, twice the rate of Casa Grande, suggesting the bedroom community could soon be the largest city in Pinal County.

One of the lessons I have learned in my 30-year career in self-storage sales is that real estate is cyclical. You can count on the fact that the market conditions you operate in today will certainly change.

Bill Alter has been an associate member and member of the Arizona Self Storage Association Board of Directors for 20 years. He is managing director of the self-storage specialty group at Rein & Grossoehme Commercial Real Estate.