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Question:

What do you see as the biggest challenge for the self-storage industry in 2016?




Kenneth E.Nitzberg
Chairman and CEO
Devon Self Storage Holdings (US) LLC

My biggest fear is that our industry will not remember the lessons of the mid-2000s, learn from them, and work diligently to avoid doing the same thing yet again, which would hurt everyone in the industry.

Our industry has just gone through three years of unprecedented prosperity, and all signs point to another year of similar results. Occupancies are at historic highs, with annual increases in gross revenue and NOI growing by double digits every year; however, these historic results can have a dark side.

Industry-wide successes have attracted the attention of many large Wall Street firms, private equity funds, high net-worth family offices, off-shore investors, and retirement plans. It seems everyone wants to get into the self-storage business as it is an easy way to make great profits. Reality is, however, somewhat different.

These potential new players often have little or no knowledge of how to build, purchase, or—most importantly—manage a self-storage portfolio, but they have cash to spend. They have no idea of the management intensity required where thousands of tenants are all on 30-day rental agreements.

As a direct result of all of this new interest, cap rates have been compressed to historic lows and asking prices have risen to the point where it is almost impossible to acquire a quality self-storage asset in a top 25 MSA. With few properties to buy that make sense and a great deal of pent-up cash that wants to come into the industry, I fear we could undergo a building boom reminiscence of the mid-2000s when in addition to overbuilding in many markets we also experienced over leveraging and poor decision making with respect to those newly built assets. Thus, even the self-storage industry, which is alleged to be recession resistant, experienced a significant decline in value and a precipitous drop in operating income from mid-2007 to 2012.

James Hafen
General Manager & Industry Principal, Self-Storage
Yardi

The industry is coming off yet another fantastic year of profitability and overall growth. Maybe the biggest challenge in 2016 will be maintaining momentum? There are many obstacles in the way to keep up this pace: Properties are expensive and the REITs are dominating the technology space. Growth through acquisition is costly, and competitive pressure from the big players is putting a squeeze on optimizing yield at existing properties.

Those of us in the Yardi offices are biased; however, we know technology concerns persist almost across the board. Metropolitan markets demand technology to stay on pace with the REITS who would otherwise like to control the web and mobile market for customers. And, of course, everyone wants more from technology providers to create efficiencies and increase customer satisfaction; tightly integrated solutions would certainly alleviate much of the headache operators have to endure to stay technically competitive.

In addition to mobile and web technologies, we have seen a real spike in the number of operators talking about revenue management, and the solutions they are looking for go beyond what has traditionally be offered in the space. Again, the technology push from the big guys is having a trickle-down effect on everyone as it pertains to pricing strategies. While sophisticated solutions are increasingly available, we also hear from a fair share of our friends that think the entire proposition is being over thought, made far too complicated.

Overall, closing the technology gap may be the biggest concern for smaller operators. In 2016 it is simply not enough to manage basic transactions at the lowest possible spend for the technology. The REITs have proven that technology spend is not a necessary evil, it’s an investment that pays huge dividends.

Caesar Wright
President
Mako Steel, Inc.

Caesar Wright
President
Mako Steel, Inc.

From a new construction standpoint, I think the biggest challenge developers will face in the coming months is meeting expected construction schedules. The commercial construction industry has been steadily ramping up over the course of the last 18 months, and the resources that specialize in self-storage construction are operating at full tilt. We are hearing from our clients that architects, engineers, general contractors, and subcontractors are all experiencing an unprecedentedly high volume of work. This is leading to extended lead times for construction documents, increased time lines for permitting, and, after the permit, dealing with a shortage in the labor force that may hinder schedules.

If there was one piece of advice I could give developers this year, it is to start early and plan for patience. Construction planning is so precarious as it is that delays, for any reason, are tough to swallow. If we are all walking into the next boom, with our eyes wide open and holding on to realistic expectations, I think it will save some folks some serious heartburn over the next year.

Vendors too, I think, will experience some challenges this year in balancing the demands of clients that have timing expectations and the demands that growth and new hire training create when times are good. A friend of mine recently said, “You know, there are two things that can take down a business: not enough work and too much of it.” So, I think, we, as vendors, are going to have to be patient too, and make smart decisions about workload. Yes, 2016 is going to be a wild ride! We’re gearing up, we’re excited, and we are counting our blessings.

Thomas R. Sherlock
Principal
Talonvest Capital, Inc.

Self-storage owners with financing needs in 2016 should benefit from the growing number of debt providers active in our industry; unfortunately, headwinds in the form of increasing regulatory pressures coupled with a rising interest rate environment are building.

Borrowing rates are the combination of an index, such as the 10-year Treasury or swap, plus a credit spread. For several years it was common for the index and the credit spread to work in opposite directions; if yields increased, credit spreads tightened and borrowers didn’t experience meaningful movements in their loan rate. But, last year, that dynamic started to change, and that may continue in 2016.

Regarding the index side of a borrower’s note rate calculation, Treasury yields increased from 1.68 percent at the end of January 2015 to a yield of 2.3 percent in mid-December. Unfortunately, the consensus in the Bloomberg and Blue Chip forecast is an expectation for that trend to continue, with the yield to be 2.82 percent by the end of 2016. Meanwhile, new CMBS risk retention regulations, scheduled to be effective later in 2016, require either the originating lender or the B-piece buyer to hold a certain portion of the loan for at least five years.

The reality is that either lenders will incur added charges against their capital or B-piece buyers of CMBS bonds will be forced to create processes that they don’t have currently in place in order to handle the regulatory requirement. Either way, the result could be increased costs passed on to the borrower in the form of higher credit spreads. Meanwhile, new HVCRE regulations on storage construction lenders are causing increased pricing for new construction loans. Keep an eye on those headwinds! Our expectation is that borrowing will be more attractive earlier in 2016 as compared to later.

Steve Mellon
JLL Managing Director, National Self Storage Team

The self-storage industry has experienced a resurgence in terms of demand, development, and value. Currently, approximately one out of every 10 households utilizes self-storage. After a period of reduced activity following the 2008 recession, self-storage construction has been increasing since 2013. While it is an exciting time for the industry, the sustained growth in development activity will pose new challenges to the self-storage market in 2016.

One of the biggest challenges that the self-storage industry will face in 2016 is unbridled development as a result of the increase in new construction. In order to have a successful development, developers need to build strategically and account for current/future supply, location, and quality.

Developers need to account for not only the existing supply in a sub-market, but must also be aware of all planned or proposed developments that may be in the pipeline. Developers should also be aware of existing properties with excess land, which could be used to construct additional self-storage units.

Self-storage is a retail business, thus location is still a big factor to a successful development. Without doing proper research, a developer might enter a sub-market that needs storage but settle for a parcel that is in a secondary location. Two examples of location missteps include sites with poor street visibility and difficult ingress and egress. Traffic volumes are another aspect that must be considered when selecting a location.

The increase in construction and competition has driven up the quality standard of self-storage facilities. You can’t just build garage space anymore. In today’s market, self-storage facilities must be attractive and include a wide range of amenities. Not conforming to modern construction standards can detract from a property and achievable rental rates.

The challenge posed to the self-storage industry by unbridled development is the potential for an over-supplied marketplace that does not adequately serve the customer base.

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