Is There A Threat of Overbuilding?
Charles Plunkett, president of CAPCO Steel, has specialized in self-storage construction for the past 32 years; during that time, his company has built more than 70 million square feet of storage space in 38 states. But for the past two years, Plunkett has narrowed his focus to virtually a lone state: Texas.
That’s because San Antonio-based CAPCO has so much construction work in the Lone Star State that Plunkett doesn’t want to spread his company too thin by taking on more projects outside of that area.
“We expect our sales revenue to increase by nearly 50 percent for 2017 over 2016,” Plunkett reports. “We have an opportunity to do more than that, but it’s limited by our ability to take on the work. We are so busy in Texas that we hardly travel anymore.”
Those words may make numerous self-storage veterans cringe because of the prospects for overbuilding and all its ramifications: unhealthy competition, falling occupancies and rents, and that “four-letter” word called concessions. Self-storage development has been trending upward for at least the past three years, with the peak expected this year before stabilizing in 2018.
“Development has kicked way up from the 2010 through 2014 period,” says John Good, president and COO of Jernigan Capital. “For 2016 there are around 600 facilities delivered, and 2017 is supposed to be the biggest year in the cycle with some estimates as high as 900 facilities delivered into 2018. Then it most likely drops in 2018.”
This data comes from the municipal offices of planning and development as well as storage real estate investment trust (REIT) reports. Good cautions that a number of these planned developments might not make it past the entitlement or permitting process to see the light of day.
Nevertheless, actual self-storage construction is happening at a level not seen since before the Great Recession. That’s good news for contractors specializing in self-storage.
Plunkett estimates that CAPCO experienced a 50 percent to 60 percent increase in construction activity in 2016 compared to 2015. Virtually all of the company’s efforts are focused on new construction projects.
SBS Construction in Boerne, Texas, has seen steady bumps in building activity in recent years as well. “We’ve probably grown at a 25 percent clip for past three to four years,” reports Ted Culbreth. “Probably 90 percent of what we do is new construction.”
The company builds projects primarily in Houston, Austin, Dallas, and San Antonio in Texas, as well as New Orleans, Baton Rouge, and Lafayette in Louisiana.
Contractors outside of Texas also are enjoying the good times. “This is as busy as I’ve seen this industry,” says Caesar Wright of Carlsbad, Calif.-based Mako Steel. “We had our best year on the books in 2016 as far as volume. We’re not seeing any kind of slowdown at all—it’s quite the opposite.”
Wright estimates 75 percent of Mako’s projects are new builds, which may be the highest level in the company’s 24-year history. Wright has seen extensive activity in Washington, Oregon, Colorado, Utah, Arizona, and California.
Self-storage facilities are located just about anywhere, but new housing communities usually attract the attention of developers and owners.
California, with the country’s largest population, has the land to accommodate even more housing and subsequently storage. “Jernigan Capital is looking at the Bay area in places like Santa Cruz, Antioch, and areas around San Jose and the Monterrey Peninsula,” Good says. “There is opportunity in Southern California from North San Diego County up into Orange County. There is some opportunity close to population in those areas.”
San Francisco has seen its share of urban infill residential and high-rise apartment development, but California regulation must be met for self-storage to be sited.
“The regulatory climate in California is very pro-environmental with a focus on lifestyle, so getting a self-storage facility entitled in downtown San Francisco could be somewhat challenging. The same probably holds true with LA,” Good says. “The other major thing a developer has to consider going into a market like that is land prices. Because you’ve had so much multifamily development and also retail and office development, land prices have gotten high, making self-storage a harder economic deal.”
These types of barriers to entry help to keep markets from overheating, perhaps contributing to California’s relatively low amount of storage space for its population. The 2017 Self-Storage Almanac reports that California has 5.2 square feet of storage space per person compared to a national average of 6.82. The Los Angeles metropolitan area has 3.89 square feet of storage per person, while the San Francisco metro area has 4.46.
This statistical information does not necessarily mean that California cities and the state have an immediate need for self-storage, but it could indicate that certain pockets may be underserved.
The same cannot be said for other areas of the country. “Texas is in danger of being overbuilt,” Good says. “We’ve done a fair amount of quantitative work in Dallas-Fort Worth, as well as Austin, and believe new supply coming into those two locations significantly exceed what we think demand is based upon the number facilities in those markets already and population growth. We’ve called those two cities out as being danger zones for new development.”
Good adds that Houston and San Antonio, while not as intensively active as other Texas cities, still exhibit some risk of overbuilding.
Jernigan Capital also has designated a “Watch List” that includes Denver, Houston, Phoenix, and San Antonio. The company’s “Worry List” has a membership of Atlanta; Miami; Charlotte, N.C.; Nashville, Tenn.; and San Jose, Calif.
A market makes the “Worry List” when the current pipeline of new supply exceeds five percent of existing supply. The “Watch List” contains markets where new supply exceeds 7.5 percent of current supply, and the “Danger Zone” is 10 percent or more. Jernigan advises against building in “Danger Zones” and to be very careful in markets on the other two lists.
Texas has 8.13 square feet per person, or nearly 20 percent above the Almanac’s national average of 6.82 square feet. Focusing on individual metropolitan areas, Austin has 7.85 square feet per person, or 15 percent above the national average. While that number may indicate Austin is overheating, the more populous areas of Dallas (7.29 square feet) and Houston (7.21) are only slightly above the national average, yet are considered to be in danger of overbuilding.
“We believe the projects we’re involved with in Denver are well positioned and well located, but there is a lot of development work going on in Denver and there could be a supply problem there,” Good says. “Miami Dade County is a huge market and historically has been low self-storage coverage per capita, but there’s an awful lot of development going on now in some of the submarkets in the Miami MSA [Metropolitan Statistical Area].”
Mako Steel is active in Colorado, and Wright concurs with Good’s assessment. “We look at the Denver market, and I am baffled by how much construction is going on in storage in the Front Range,” Wright observes, referring to a stretch that runs north and south along the foothills of the Rocky Mountains. “I’ve heard of more than 60 [facilities] that are either in planning and zoning or permit or construction in the Front Range.”
Denver is frequently cited as an area in danger of oversaturation, yet its average of 5.6 square feet per person is well below the national average as well as the state average of 8.6 square feet in Colorado. Perhaps Denver is playing catch-up to meet pent-up demand, but the general perception is that the market is overheating.
While the Pacific Northwest is not frequently mentioned as an overbuilt market, Wright sees construction heating up there. “The activity we’re seeing in the Portland market is overwhelming to me,” Wright says. “We have three currently under construction; there are a half-dozen more that are under construction that I’m not part of with a lot more on the books coming. It’s a bit baffling how much I see in Oregon, Washington, and Denver.”
Once again, overbuilding may be in the eye of the beholder. What may look like excessive activity may not be supported statistically.
“The REITs will tell you the boroughs in New York are at risk of being overdeveloped, but the thing to remember about New York is their self-storage coverage per person is very low—it runs two to three square feet per person,” says Good.
But all self-storage is local. As the Almanac points out, most facilities draw at least 75 percent of their tenant base from within a three-mile radius. In high-density suburban markets, tenants rarely come from outside a 1.5-mile radius.
“Having 6.82 square feet per person across the U.S. does not mean that’s equilibrium for the industry on a nationwide, statewide, or market-wide basis,” the Almanac notes. “It is merely a statement that the size of the supply side of the U.S. market is 6.82 square feet per person.”
While a metro area may be near the national or state average, pockets of a city may be oversaturated with self-storage as too many facilities crowd into a given marketplace.
According to the Census Department, between 2010 and 2014 there was just over $2 billion of self-storage built. In 2015 alone there was $970 million spent on self-storage construction. This amount was needed to absorb the excess demand created by little new storage being built during the recession years.
Jernigan Capital estimates 2016 storage construction spending to be $2 billion, or about double the amount of development in 2015.
Based on the most important demand driver of population growth, the industry was still behind the amount of storage needed to be built in 2015. “However, in 2016, we’re on pace to build roughly 25 million rentable square feet of storage when we only need about 71 percent of that,” according to the Almanac. “If we continue to build at the pace we’re seeing in 2016 and likely to see in 2017, occupancies, rental rates, and the sector as a whole will suffer greatly.”
Like most economic trends, self-storage development runs in cycles. “For the last 20 years I’ve been saying, they’re building so many you’d think they would have to quit building at some point,” Plunkett observes. “They’ll slow down for a while and fill them up and then they’ll build more. What I expect is a repeat of that; I think they will slow down development. There will be a lull for a while. History repeats itself, and I’ve watched it do that for 32 years.”
New Look Developers
Unlike the previous boom cycle, the vast majority of locations are carefully studied before a shovel goes in the dirt. New storage developers are more sophisticated and have done their due diligence before breaking ground. Contractors say most of the new facilities are being put up by traditional self-storage developers, although a growing percentage represents new players entering the sector.
“In the last year, maybe a little more than normal, we see multi-faceted, large development companies that are in retail, shopping centers, office buildings, multifamily, and all kinds of real estate development, and they’re adding self-storage to their portfolios because they recognize it as a good hedge against other types of real estate investments,” Plunkett reports. “There are more people active today in the market that weren’t previously in the self-storage development industry.”
Some of the new storage developers have extensive experience in other real estate sectors. “Some developers are coming out of multifamily or retail where the site selection process follows the same method. They have good experience working with zoning authorities and planning commissions,” Good says. “We’ve seen a couple hotel people migrate into the space, and they did a good job with site selection and are very much up the curve on how to construct these things and how to get them zoned.”
Growing Municipal Regulations
Self-storage traditionally has run into municipal obstacles when it comes to siting and building facilities, and the new breed of stores with their pleasing architectural features and modern amenities help to facilitate approvals in some communities.
Yet, storage, along with virtually any other development, has higher hurdles to cross to win municipal approval these days. Municipalities are demanding improved safety measures, energy efficiency, and environmental regulations.
The 2015 International Energy Conservation Code (IECC) has been adopted by most municipalities, requiring contractors to build in additional energy-saving features.
“That code requires things that make a building more energy efficient such as increased levels of insulation,” Plunkett says. “You have to have a roof that has a high reflectivity index, which means you have to put a special white roof on it. You have to have a continuous insulation barrier around outside the perimeter walls. Air conditioning systems have to have economizers. That adds significant cost to your project.”
Environmental add-ons can be costly, but building owners still can benefit from the expense. “Your second largest cost is utilities, so if you are reducing your utility cost significantly, you’re adding value to the bottom line,” Plunkett says.
“Right now the focus in our marketplace is water control,” Culbreth says. “What are you going to do with water that falls on your property as rain? Are you going to retain it? How is it going to get off your property so it doesn’t affect people downstream?”
Fire protection remains another community concern. Fire hydrant placement, turning radius for fire trucks, access for fire vehicles, and sprinkler systems all receive special attention from local authorities.
One of the great needs for storage is in urban infill areas, where residents live in new high-rise apartments and condominiums that lack sufficient space.
“They’re small parcels, so the footprint is on a one-to-two-acre parcel and most are going vertical due to land cost and to try to achieve that gross unit mix to generate revenue,” Wright says. “We do a lot of multi-levels now, probably more than we’ve ever done. I’d say half of our job board is multi-level. With that comes more municipal restrictions.”
Conversions are still a relatively affordable way to place self-storage in many metro areas. Wright says there are numerous Sports Authority and Kmart buildings available for conversion to storage along with movie theaters, furniture stores, and even an old paper mill.
“The infrastructure is in place,” Wright says. “Most of the time you have to make modifications to the foundation to support the load for the deck. They are very attractive because they can typically move through the permitting and planning check faster.”
A method of adding “instant storage” is to demolish part of an existing facility and build multi-story additions. Although the price tag may be high, the beauty of this strategy is that the land is already zoned for storage.
Business is buzzing for contractors as self-storage sprints to catch up with demand. But is the industry headed for an overbuilding outbreak?
“Everything runs in cycles, and this cycle is being driven by substantial supply and demand imbalance that you had following the Great Recession,” Good says. “From 2010 to 2015, supply became extremely depressed relative to population growth and demand.”
Despite the frenzied development activity, there is still a strong demand for self-storage across the United States, according to the Almanac, but adds this caution:
“As we enter the second half of the development cycle, we must be more careful about where we build and how much we build. In the first two years of the development cycle, good self-storage sites were low hanging fruit. Now they are going to be tougher to find. They are out there, but developers are going to have to do more homework. In the end, that extra homework will be worth it for everyone.”
David Lucas is a freelance writer based in Phoenix, Arizona. He is a frequent contributor to all of MiniCo’s publications.