While we have all likely sighed in relief that 2020 is finally behind us, the new year begins with some of the familiar uncertainties that plagued the nation throughout the previous 12 months. In some states across the country, a second wave of COVID-19 has once more forced governing bodies to impose face mask and social distancing requirements, sending students and employees alike back home for virtual learning and telecommuting. Gatherings are limited, and many social events have been canceled. Medical facilities and hospitals are scrambling to accommodate an onslaught of new cases, with beds filling faster than they are clearing, and quarantining as well as travel restrictions have become the norm yet again.
A Silver Lining
Though it may seem like a dreadful continuation of the year we’d all love to forget, at least the outlook for the self-storage industry remains bright. In fact, according to Chris Sonne, executive vice president of Newmark’s Valuation and Advisory Group, the performance of the self-storage industry is nothing short of remarkable. “Self-storage outperformed all core commercial real estate markets in 2020,” he says, noting that REITs experienced double-digit year-over-year growth compared to 2019.
Indeed, the self-storage industry has once again proven its resiliency during economic downturns. While Sonne acknowledges that the sector isn’t immune to the ill effects of recessions, or “recession-proof” as some like to say, he is adamant that the asset class is certainly “stable and steady” and should continue to be for the foreseeable future.
For instance, Sonne mentions that there were more large portfolio transactions in 2020 than there had been since 2016. And one of those was actually the Simply Self Storage deal priced at approximately $1.2 billion; it traded hands from Brookfield Asset Management Inc. to Blackstone Group, Inc. Despite some substantial consolidation in 2020, he is quick to add that the industry is still very much fragmented as far as ownership is concerned, and there is “a long way to go” before it becomes institutionalized.
Sonne goes on to say that there hasn’t been a shortage of new players to enter the industry either, including some hefty investors, such as Blackstone, the largest alternative investment firm in the world, and Cascade Investment, L.L.C., which is controlled by Microsoft mogul Bill Gates.
In addition to these fiscal factors, the self-storage industry is fortunate to have what Sonne calls “sticky” customers. Because the majority of tenants tend to store items with sentimental value, they are less likely to purge their units to reduce their household expenses. He states that when you look at the average percentage of household income spent on self-storage, it equates to about two percent or less. “It’s not at the top of the list,” he says, when it comes to budget cuts. And as for commercial tenants, some have been forced to shutter their doors or downsize their operations, while others require storage space for excess inventory or place to stash reserves of PPE and cleaning supplies. Either way, the changes brough about by the pandemic have increased self-storage demand in many markets throughout the United States.
What’s more, Sonne notes that the “tremendous success” of contactless rentals has made self-storage more accessible. “It was a perfect time to implement it,” he says. “People love it.” Although it had been thought that only the tech-savvy millennials would be using it, Sonne states that it has been appealing to the general public in light of the ongoing pandemic. He also believes that the industry will see continued improvement in technologies that will lessen the emphasis on site management, a shift that would slash operational expenses and make self-storage investments even more profitable.
With a substantial amount of capital chasing the sector, Sonne expects more activity in 2021. Naturally, some of that activity includes new development. Therefore, he stresses the need for thorough due diligence.
Though there are always speculations about the vitality of various markets, Sonne urges developers to reject those assumptions and complete exhaustive research specific to the trade areas. As an example, two MSAs that have been frequently labeled as oversupplied, Denver and Miami, may have pockets of opportunities. Sonne states that trade areas within those MSAs could be viable and he has confidence in both markets due to their good fundamentals such as increasing populations and job growth.
The need to “drill down” to a “small and measurable” trade area is imperative to determining feasibility. As Sonne points out, that market research could produce a different outlook. “The drill down could be bad,” he says, reiterating that developers should focus on trade area fundamentals such as the barriers to entry and supply/demand ratio. “Just because it is underserved doesn’t mean it’s a good spot.”
Moreover, Sonne advises developers to be open to possibilities outside of primary markets within the top 100 core based statistical areas (CBSAs). “There are great returns in secondary and tertiary markets,” he says, noting that some of the best deals with good cash flow and good returns are coming from secondary MSAs.
This is especially good news considering that some city dwellers have been seeking housing within suburbs and the outskirts of city limits as a response to the pandemic and new telecommuting options. On another note, Sonne doesn’t foresee this shift impacting the valuations of self-storage facilities located in primary markets. “Core cities are hard to build in due to the economic limits,” he says, which means they should retain their high values and appeal.
Speaking of alternative options, Sonne brings an emerging trend to light: “micro mini-storage.” According to Sonne, developers have been building small self-storage facilities, totaling approximately 10,000 square feet, in dense neighborhoods where storage space is needed. These micro mini-storage facilities have been successful in areas where apartment and condominium dwellers are prevalent as well as coastal cities. Sonne adds that these micro mini-storage facilities are working well and operating via kiosks. With “really good returns,” he calls them a “high yield project” for entrepreneurs and developers.
However, regardless of the project, Sonne is adamant that self-storage owners and developers should continue to “make disciplined decisions,” especially when it comes to managing cash flow. This includes raising rents if physical occupancy is too high.
The Year Ahead
Although uncertainties abound, Sonne is optimistic about the future of self-storage and has a robust outlook for the industry in 2021. The grounds for his confidence include:
- Low interest rates and money available
- Good fundamentals
- Good sentiment
“There has been a significant downward shift in cap rates due to interest in the sector,” he says, adding that self-storage continues to be a “safe” investment. Sonne also believes that interest rates will remain low for many years to come.
Nevertheless, he does mention that the new administration at the White House could cause some growing pains. “If they increase taxes and regulations, it could be painful to the economy,” says Sonne, who’s keen on taking a “wait and see” approach before curbing his enthusiasm.
But whether the new year brings troubling tax hikes or slightly calmer waters, Sonne is certain about one thing: The need for storage space will remain. So, batten down the hatches and ride out the second wave!