Following the unprecedented development wave in 2018, the self storage market in Texas has become significantly oversupplied. Metros such as Houston, Austin, San Antonio and Dallas-Fort Worth were all compelled to limit their new development pipeline to help balance supply and demand.
However, due to the high demand driven by pandemic-specific factors, almost all major Texas markets registered double-digit rent growth. Multi-Housing News reached out to Bill Bellomy, principal of Bellomy & Co., to discuss the current self storage landscape in Texas, and how COVID-19 was a catalyst in restoring market momentum.
How would you describe the Texas self storage market more than one year into the pandemic?
Bellomy: Every facility for sale is priced to perfection and operating fundamentals are as strong as they have ever been. Street rates are 30 percent higher than 2018 levels and occupancy levels are pushing 90 percent.
You would be hard-pressed to find a facility in Texas that did not have its best operational and financial month in July. Peak occupancy, peak rental rates, peak net move-ins year-to-date. Every class of facility (A, B, C) and every geographic submarket of Texas is experiencing this.
Texas markets were notoriously oversupplied due to the development boom in 2018. What can you tell us about supply and demand now?
Bellomy: The slowdown in new openings in the last 12 months has allowed for natural absorption of vacancies. The biggest surprise to me is the absorption in supply coupled with the dramatic increase in rates. Usually, it’s one or the other, rarely it is both—occupancy and rental rates—at the same time.
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Austin, Dallas-Fort Worth and Houston have all registered significant rent growth in recent months. How do you expect these markets to perform after the pandemic-specific self storage drivers dissipate?
Bellomy: The first driver we are monitoring is the normal seasonality of rates and occupancy. Will we see move-ins and rate growth slow like we typically do in the fourth quarter of the year, or is the post/current pandemic boom going to buck the traditional seasonality?
We are seeing developers wanting to develop, but having a hard time making deals pencil due to the increase in construction costs. If rental rates stick and sub-five-percent cap rates persist, developers will be able to make new development pro-formas work. It will take 24 months for new deals to get capitalized and developed, so we have a healthy runaway of operating fundamentals for existing facilities.
What can you tell us about investor sentiment across Texas? What type of properties are buyers looking for?
Bellomy: It’s a cliché, but buyers are looking for all types of deals and all geographies. We have seen tremendous cap rate compression in second and tertiary markets and Class B and C deals. We joke about the fact that we no longer need pictures or maps in our marketing materials because buyers are underwriting net operating income, all the same, agnostic of the quality or location of the facility.
What are the biggest challenges in the self storage financing landscape in Texas?
Bellomy: Financing is taking longer because lenders rely on, and are beholden to third-party vendors—survey, environmental, PCA, feasibility, etc. Every vendor in real estate is “backed up” so taking longer to finish reports. Banks are also a little skittish on new construction because of the recent memory of so many development deals missing pro-forma assumptions. However, there is no shortage of lenders wanting to finance existing facility acquisitions.
How does the Texas self storage market compare to other markets you operate in?
Bellomy: The Texas self storage is as strong as it has ever been but will likely get even better. Every major institutional source of debt and equity wants exposure to the Texas self storage market and will be a premium to make that happen. I think cap rates could compress even more. Operating fundamentals are strong and will continue for the foreseeable future. Deep-pocketed institutional buyers, record net operating income, slow down of new construction coupled with strong Texas population growth are creating record valuations.
What is your prediction for the self storage industry going forward?
Bellomy: More of the same, record number of transactions, continued rent growth, and a slow uptick in new construction over the next 18-24 months. More institutional buyers will look to get into the asset class and pay a premium to do.