The Base Case for Self-Storage; A Passive Investment Sector to ConsiderMay 29, 2023 - By Wolfgang Suess
Boston — The self-storage industry had a humble beginning in the 1960s - in Texas, where real estate developers built rows of prefab sheds with garage doors on the outskirts of town and rented them for 50 cents per square foot, per month. Developers saw a behavioral pattern that did not match the living patterns of families in the United States – where we accumulated a lot of stuff yet never had enough space in our dwellings to store all that was being saved.
On the demand side, not much has changed in self-storage over the past 50 years, save for accumulating even more objects, adding new technologies, outdoor furniture, financial records, and coveted keepsakes to our homes, with woefully too little space to store all that we hold on to. Today’s population is far more mobile while aging - leading to lifestyles that create a growing need for places to store our things. Self-storage has become a norm and a necessity for many Americans.1
Countering long drive times to remote outskirts, the industry has, profitably and acceptably, built storage buildings within neighborhoods. The former rows of garage doors in secluded and sometimes seedy sections of town have been replaced by very attractive multi-story Class A buildings at ‘Main and Main’ in the nation’s largest cities.
The institutionalization of this property type has increased awareness and usage of the self-storage product over the years. The result – the 50 cents per foot monthly rent has grown exponentially, and self-storage rents in major metropolitan areas are now highly correlated to Class A apartment rents.
The evolution of this category has produced the highest shareholder returns in the commercial real estate sector. According to information published by the National Association of Real Estate Investment Trusts, the industry association for United States REITs, over the past 29 years self-storage REITs have led all REITs in total shareholder return, with an average annual total return of approximately 17.25%, nearly 225 basis points higher than the next-highest returning sector. 2
With the impressive returns, It is no surprise that real estate investors continue to add the asset class to their portfolios. According to the Self Storage Association, the sector has been the fastest-growing segment of the commercial real estate industry over the last 40 years. The demand continues to strengthen as healthy job growth, rising wages, increased mobility, and the formation of new neighborhoods support the need for storage. Nationally, the self-storage sector experienced double-digit revenue and net operating income growth in 2021 and 2022 and has entered 2023 with continued strong customer demand and historically high occupancies per S&P Global Market Intelligence.
Self-storage demand is driven in large part by life events. Many in the industry refer to the five Ds of self-storage – death, divorce, dislocation, downsizing, and disaster, while the Covid pandemic introduced another D – decluttering. 3
With impressive scale opportunity for rent growth, the self-storage customer assembles from all generations, with the vast majority of renters being from the Millennial (34%), Gen X (34%), and Baby Boomer (27%) - and Greatest & Silent (3%) generations. More than 50% of self-storage customers rent storage for more than one year and the average length of stay of a self-storage customer in a facility is now greater than 14 months.
The typical customer receives a rent increase after as little as four months following the initial rental of the unit, with additional increases every 9 to 12 months thereafter. Self-storage is not conducive to pre-leasing, due to its monthly, need-oriented leasing structure. Depending on facility size, between 3 and 4 years is required to reach a “stabilized” occupancy rate (generally 85%) for a new facility and 4 to 5 years to reach economic stabilization (i.e., the stabilized occupancy rate at stabilized rental rates with normal concessions and discounts). During lease-up years, new self-storage facilities will experience higher than normal occupancy, revenue, and net operating income growth rates.
Following economic stabilization, self-storage can be expected to deliver annual rent growth that exceeds the inflation rate. From the period 1994 through the third quarter of 2022, the cumulative annual growth rate for self-storage rents was approximately 4.3%, compared to an inflation rate of approximately 2.5%.
During the same period, the net operating income growth rates for self-storage REITs averaged over 5%, leading all other REIT sectors over that period. The combination of strong rent growth and real estate industry-leading net operating income growth has driven top-tier risk-adjusted returns for investors for more than two decades.
Given its demanding needs and projecting its future growth, many view the asset as a strong opportunity for accredited investors to gain exposure to the self-storage sector. As with any other commercial real estate type, risks to self-storage investors exist.
If you are an investor looking to invest passively in the storage sector, we would be happy to talk with you. We have access to storage Delaware Statutory Trusts (DSTs) for 1031 exchanges, Opportunity Zone Funds, and other tax advantage storage investments.
Wolfgang Suess is Senior Vice President, New England. for Great Point Capital. He specializes in real estate tax deferral strategies.