A New Class Of Investors
Since the Great Recession, the self-storage sector has grown by leaps and bounds. With a shortage of supply, growing populations, and increased demand in many MSAs across the country, operators of stabilized facilities managed to push their rental rates and occupancy levels to all-time highs. Net operating income (NOI) has improved at well-managed locations, facility valuations have escalated, and plenty of properties within the top MSAs have been selling above asking prices. At the same time, numerous newly constructed properties have exceeded their lease-up projections by considerable amounts.
The self-storage industry’s ability to outperform other real estate classes during the recession, as well as its exceptional post-recession performance, hasn’t gone unnoticed. As a matter of fact, it has resulted in a significant influx of institutional capital, especially from new investors eager to enter the asset class.
In the not-so-distant past, real estate investment trusts (REITs) were the investors within the self-storage industry with the deepest pockets. While the publicly traded self-storage REITs (Public Storage, Life Storage, CubeSmart, Extra Space Storage, National Storage Affiliates Trust, and U-Haul International—a publicly traded non-REIT) are still investing, and will continue to do so, Ken Nitzberg, chairman and CEO of Emeryville, Calif.-based Devon Self Storage, points out that change is afoot.
“There’s a whole new class of investors,” Nitzberg says. “The REITs have really slowed down, almost to a trickle.”
He credits the more selective approach being taken by the REITs for opening the playing field for others to invest in self-storage. “Public players have an advantage over private companies,” says Nitzberg. “Ninety-nine times out of a hundred, REITs can win a bidding war. Now, others with higher cost of capital are buying.”
According to Nitzberg, there are three other major types of investors besides REITs: private equity funds, high-net-worth family office, and regional operators. He says that private equity funds are “spending serious money” on self-storage investments, but they “want to make meaningful deals” that can yield high returns, especially if they plan to sell those investments after a four-year to seven-year hold period. As an example, Devon Self Storage seeks an IRR (internal rate of return) in the mid-teens after a four to six-year hold. “It’s all about the return,” says Nitzberg.
In other words, as Nitzberg goes on to say, private equity funds are unlikely to invest in deals under a certain dollar amount. “Those under $2 million are not worth their time,” he says, adding “maybe not even under $5 million.” For the most part, private equity funds are looking for deals within the top 20 MSAs. “They want to be where the REITs are,” says Nitzberg.
Shawn R. Hill, principal of Chicago, Ill.-based The BSC Group, LLC, agrees that most of the institutional capital is focused on the top tier markets, but asserts that “some [investors] have specifically identified strategies to focus on the secondary and, even in some cases, tertiary markets.”
Noting that private equity firms have more than filled the investment gap left by REITs, Marc A. Boorstein, principal of Chicago, Ill.-based MJ Partners Real Estate Services, says, “REIT buying is down 60 percent or more since last year.” He adds that this is the result of a lack of investment capital on their part.
This notion is contained within in MJ Partners’ Self-Storage Market Overview for Q3 2017 as well: “Overall, self-storage transaction volume by the public companies lower by over 60 percent compared to last year, including reduced certificate of occupancy transactions. While balance sheet acquisitions from public companies continue to flat line, the growth of joint venture acquisitions remains robust.”
However, as Boorstein indicates, private equity firms have plenty of capital. “They are aggressively raising close to billions and want to partner with operators,” he says. Boorstein claims he meets with at least one private equity firm each week that wants to invest in self-storage.
“Private equity is providing acquisition capital to acquire assets,” Boorstein says, noting that many are seeking partnerships with reputable self-storage operators to build portfolios. “Private equity has been very aggressive. They can compete more with the REITs now.”
As examples, Boorstein quickly rattled off a handful of the private equity firms that have invested large amounts of capital into self-storage over the past few years:
- Brookfield Asset Management, Inc., a Toronto-based global asset manager that acquired Simply Self Storage, which ranked seventh on Mini-Storage Messenger’s 2017 Top Operators List, for $830 million in 2016.
- Oakland, Ill.-based Inland Capital Corporation (IPC), which formed a strategic partnership with Metro Storage LLC (no. 10 on the 2017 Top Operators List) to facilitate the purchase of 42 self-storage properties since February 2016 for programs sponsored by IPC.
- SmartStop Asset Management, LLC (no. 11 on the 2017 Top Operators List), is once again raising capital through several funds to grow its platform after selling SmartStop Self Storage, Inc.’s previous assets (122 owned and 43 managed stores) to Extra Space Storage in 2015 for $1.4 billion.
- The Carlyle Group, a global alternative asset manager that teamed up with Irvine, Calif.-based Westport Properties Inc. (WPI) in 2016 to fund new storage developments. WPI, which ranked 13th out of 100 on the 2017 Top Operators List, operates facilities under its US Storage Centers brand.
Another noteworthy example is Charlotte, N.C.-based Morningstar Properties (no. 20 on the 2017 Top Operators List), which secured a $90 million fund through its private equity real estate affiliate Blue Doors Capital Partners in 2016.
Though they have the funds, it may take a year or longer for a private equity firm to make an investment decision. “They are waiting for larger deals to happen,” says Boorstein, who also mentions that every deal he arranges has at least one offer from a private equity firm. “They are in fundraising mode for 2018. Acquisitions will start allocating soon.”
In addition to private equity, the self-storage industry has experienced a significant uptick in interest from high-net-worth family offices. While Boorstein emphasizes that some do not want their names to be disclosed, including various family offices on the West Coast, there are several that MJ Partners works with closely. “It works well for them,” he says, adding that this is due to the fact that self-storage facilities can be operated with few employees.
One of the industry’s most active family offices is Dallas-based Rosewood Property Co. (RPC), which is a subsidiary of The Rosewood Corp., a private investment concern owned by the Caroline Hunt Trust Estate. As of October 2017, its portfolio included 41 self-storage facilities within 11 states, totaling more than 3.15 million rentable square feet of storage space. What’s more, even some of the Walton family offices, various heirs of the Walmart fortune, have self-storage investments.
While there is plenty of capital on the sidelines, Hill suggests that it may take some ingenuity to place it. “It seems the investors at this point are having an increasingly difficult time finding new and creative ways to deploy a meaningful amount of capital into the space,” he says. “Some have identified new and creative ‘products,’ such as participating debt, mezzanine debt, and preferred equity. Others have shifted their focus away from core markets to focus on secondary and tertiary markets with less competition, or to development where they can find more attractive risk adjusted yield than simply competing for the limited number of core deals that remain.”
In regard to investment options, the private equity firms’ preferences are diverse as the REITs. While some are buying one-off properties, others are purchasing portfolios or funding development. For instance, Boorstein says The Carlyle Group is only funding higher return new development.
“It’s not like buying pantyhose,” Nitzberg says. “There’s no one-size-fits-all deal. Some want stabilized properties. REITs have backed off C of Os [certificate of occupancy] a great deal, but they are still slugging it out with each other for trophy properties.” He describes “trophy properties” as the new, “glass and glitter” facilities located within the top 10 MSAs. “They will bid over the asking price for trophy properties,” adds Nitzberg.
Indeed, new development is becoming a more lucrative option. “Historically, the focus has always been on cash flow,” says Hill, “however, as cap rates have continued to shrink, there has been a shift in focus to new construction, because value has widely exceeded replacement cost in many areas that have demand for new product. Depending on the mindset and goal of the investor, the strategy may vary from core deals with existing cash flow, to higher yield development, to a hybrid mix of both.”
Regional Operators On The Rise
Hill reiterates that regional operators are managing to grow their portfolios by partnering with new investors. “Since the economic downturn we have seen a lot of partnerships form between institutional equity and regional operating partners to expand investment in to the space in a meaningful way,” he says. “This is evident with the visible growth of many recognizable brands who have now become some of the premier privately held operators in the space.”
As a matter of fact, some regional operators have spread out beyond their initial regions. While some do not have self-storage facilities in enough states to be considered national operators, there are several operators with properties in multiple regions throughout the United States. What’s more, there are a few that have even expanded into other countries, such as SmartStop Asset Management, LLC, which has been establishing a presence in the Greater Toronto Area of Ontario over the past two years.
Several other regional operators have been able to grow their portfolios, and take advantage of economies of scale as well as capital, by becoming Participating Regional Operators (or “PROs”) of National Storage Affiliates (NSA), the publicly traded REIT that enables them to continue to manage their self-storage properties after they join.
SecurCare was one of the three founding PROs of NSA. The other two were Northwest Self Storage of Portland, Ore., and Optivest Properties of Dana Point, Calif. NSA’s initial trio of PROs signed the formational agreement in February 2013 and began contributing properties into NSA in April 2013. Six other PROs have since partnered with National Storage Affiliates: Irvine, Calif.-based Guardian Storage Centers, which joined in April 2014 and has facilities throughout Southern California, Arizona, and Nevada; Move It Self Storage, which joined in September 2014 and primarily operates facilities within Texas; Storage Solutions, which joined in May 2015 and operates in Arizona; Hide-Away Storage, which joined in April 2016 and has properties along the west coast of Florida; iStorage, considered as NSA’s “internal PRO” joint venture that joined in October 2016; and Personal Mini Storage, which operates properties within the Orlando, Fla., MSA. Personal Mini Storage became the REIT’s ninth affiliate in March of 2017.
NSA was ranked sixth on Mini-Storage Messenger’s 2017 Top Operators list. In September 2017, National Storage Affiliates held ownership interests in and operated 473 self-storage properties throughout 26 states, for a combined total of approximately 29 million rentable square feet.
Per MJ Partners’ Self-Storage Market Overview for Q3 2017, “Subsequent to Sept. 30, 2017, [NSA] acquired 28 self-storage properties located within eight states, for a total of $174.5 million, encompassing 1.8 million rentable square feet. The Store Here portfolio acquisition for 26 properties included locations in Texas, Kansas, Louisiana, Indiana, and Georgia. NSA also invested about $9.3 million in one additional facility.”
According to its website, “National Storage Affiliates is focused on growing through the integration of best-in-class operators with self-storage properties located in markets with strong fundamentals in the top 100 MSAs throughout the United States.”
Arlen D. Nordhagen, chairman and CEO of NSA, adds that National Storage Affiliates is especially seeking operators with facilities in geographical areas where the REIT currently has little or no presence. He says that NSA is strong in the Northwest, Southern U.S., and Southern California but “light” in the Northeast, Mid-Atlantic, and Midwest.
“They need scale to have good on-ground operations,” says Nordhagen. “NSA’s focus is on large private operators with good management teams who want to grow.” On average, NSA’s PROs have had between 40 and 50 self-storage facilities in their respective portfolios prior to joining the REIT.
What Does 2018 Hold?
Although there is a consensus that the REITs will be selective with their acquisitions in 2018, Aaron A. Swerdlin, vice chairman of Houston, Texas-based Newmark Knight Frank (NKF), notes that they will be aggressive for the right deals in core markets. They are interested in properties within the top 50 MSAs, especially the top 15 MSAs.
Overall, Swerdlin is confident that the self-storage industry is poised for another good year. With average—yet respectable—sales volume and a diverse mix of investors, he predicts that 2018 will be a continuation of 2017.
While it’s hard to say which investor type will dominate 2018, as there are many new investors and lots of capital, Swerdlin believes family office will be active throughout the year. “Family office may surprise everybody,” he says.
Furthermore, Boorstein has no doubt that additional private equity funds are on the horizon. “In 2018, I fully anticipate more private equity entering the self-storage industry,” he says.
Even so, regardless of who’s providing the capital or what’s being acquired, there still won’t be enough consolidation throughout the year to significantly impact the sector’s diverse ownership base.
“This is still a widely fragmented industry,” notes Hill, “however, it is becoming increasingly institutional with each passing day. In the top markets, it seems that the ownership is heavily institutional; however, as you move to the secondary and territory markets, there still exist a lot of smaller operators.”
Erica Shatzer is the editor of Mini-Storage Messenger, Self-Storage Now!, and Self-Storage Canada.