Are Historical Highs Behind for the Self Storage Sector?
Industry experts weigh in on what's next for this resilient market, in the fifth installment of our 2023 outlook series.
The self storage sector entered 2022 with no signs of winding down after a record-setting previous year. Investor interest and demand continued to be substantial, and the year kicked off with the Sun Belt region firmly on top in terms of annual rent growth, with some metros even seeing double-digit rent increases for almost all unit types. Overall, street-rate rents persisted in climbing even further in the summer months, but then they began to gradually temper toward the last quarter of the year, according to Yardi Matrix data.
“After two years of record performance during the pandemic, self storage continued to be strong in 2022, with rents up almost 4 percent year-over-year between the third quarter of 2021 and the third quarter of 2022,” the national director of Marcus & Millichap‘s self storage division, Steven Weinstock, explained.
But the end of 2022 came with a notable cooldown, just like in other property sectors. Can the self storage niche hold on to its recession-proof reputation? What lies ahead for the sector after a stellar performance in the past couple of years?
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“I like to call COVID-19 the ‘extra credit’ years for the self storage industry, and we’re now transitioning back to more normalized pre-pandemic trends and behaviors,” said Extra Space Storage Executive Vice President & Chief Strategy and Partnership Officer Noah Springer.
He believes 2022 was one of the sector’s strongest revenue performance years in history and attributes the impressive growth to the heightened demand throughout the pandemic that followed a previously unseen, low vacancy. This resulted in “the highest occupancy levels the sector has ever achieved,” as he put it. Now, the industry is gradually trending back to more sustainable levels.
“In the coming years, we’ll start to see revenue growth normalize and return to single-digit year-over-year growth, which is still really good, just not the numbers we were seeing in the unusual operating environments of late 2020, 2021 and the first half of 2022,” Springer clarified.
Meanwhile, Michael Wachsman, director of acquisitions at Andover Properties—a company that has a portfolio of more than 12 million rentable square feet across more than 150 facilities in 18 states—has a different way of looking at the storage industry’s performance this past year. Just as the pandemic became a firm before-and-after event, there was a similar turning point for the sector during 2022 that shattered investors’ rose-colored glasses, according to Wachsman. While he admits 2022 was a strong year for operational performance, he points out that the Fed’s aggressive rate hikes were a game changer.
“In March, the consensus called for a Federal Funds rate of 1.9 percent by year-end 2022. The current target is now 3.75-4.0 percent, with more increases to come,” he mentioned. “As a result, lenders have been selective in the back half of the year, which has negatively impacted transaction volume.”
Today, the bid-ask spread between buyers and sellers continues to widen. On one hand, buyers are pricing in increased uncertainty and more expensive financing, while sellers are still clinging to 6-months-ago pricing, Wachsman noticed.
“Some sellers are now offering seller financing, hoping to bridge the bid-ask gap. The only certainty we foresee in 2023 is continued strong interest from investors trying to increase their exposure to the self storage sector due to its favorable fundamentals, attractive operating model, and strong historical returns,” Wachsman continued.
A recession-proof sector?
Weinstock, Springer and Wachsman all agree that self storage possesses a clear advantage over other property types due to the inherent characteristics of the asset class.
“Storage has started to become a part of the American lifestyle, and we don’t see that changing during a recession,” as Springer put it.
Weinstock pointed out the sector’s unique counter-cyclical demand drivers and its flexibility stemming from monthly leases, which can alleviate potential losses incurred from lessening demand as a result of climbing interest rates and inflation. Based on Marcus & Millichap’s recent Investor Sentiment survey, the self storage sector retains its appeal due to these “recession-resistant” characteristics.
However, the Marcus & Millichap executive warned that an economic downturn could generate headwinds to cash flow growth, despite the industry’s resiliency in similar conditions—like the Global Financial Crisis.
“Investors did note that a significant increase in rates, such as 150 basis points or more, might influence their decision to continue to add self storage to their portfolios in the year ahead,” Weinstock said.
Nevertheless, self storage companies appear to be well-positioned to withstand a recession, considering they are still operating at higher occupancy than historical levels, as a result of the record demand during the pandemic.
What will 2023 hold?
Despite development activity remaining robust nationwide—as of November, the new-development pipeline represented 11.1 percent of total stock, up 10 basis points on a monthly basis, according to Yardi Matrix data—a slowdown is looming on the horizon for the self storage sector.
On the operational side, Andover anticipates that rent growth will moderate after several years of high double-digit growth in asking rents. “We will focus on maintaining high occupancy by creating attractive pricing and concessions for first-time customers,” Wachsman mentioned.
One of the biggest self storage REITs is largely on the same page. In late 2023 and 2024, Springer expects to see the surge in development and acquisitions moderate because of more normal operating returns, less abundant capital, and higher interest rates.
“For Extra Space, 2023 is going to be a year where we focus on operating at the highest level possible. We plan to stay focused on executing the fundamentals, making sure customers are taken care of, keeping occupancy and rates at a good place, and taking care of our team,” Springer said.
When it comes to investment activity this year, Wachsman sees opportunities in two areas: attractive asset pricing as monetary tightening increases the cost of debt and opportunity cost of equity, and good assets with bad capital structures.
“We expect many poorly capitalized investors will be less active buyers. Similarly, these investors may become forced sellers due to debt maturities or expensive interest rate cap requirements,” he said.
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Meanwhile, Weinstock believes that past concerns such as oversupply shouldn’t pose a threat going forward. While many markets—including Portland, Ore.; Tampa-St. Petersburg, Fla.; Phoenix; and Austin, Texas—recorded large inventory expansions in the past 12 months, the same markets reported strong demographic increases over the same time frame.
“Despite the new development, most of these markets enjoyed higher average asking rents nationally while also benefiting from substantially lower vacancy rates,” Weinstock added.
Overall, the outlook remains positive for the self storage sector, despite an anticipated deceleration. Rent growth will likely dampen, as will occupancy and development activity. And although the asset class’ staying power will endure due to demand factors such as relocations and other immutable life events, the self storage sector’s record-breaking figures will most likely be rooted in the past.