Inland Exec Weighs In on OZ, Self Storage Investment
Keith Lampi talks about his company's ventures as time is slowly running out for the OZ program.
Introduced through the Tax Cuts and Jobs Act in 2017, Opportunity Zones have attracted billions of dollars in real estate investing. The substantial tax incentives have been motivating investors to revive many underserved U.S. areas by breaking ground on new projects or repurposing old buildings for contemporary uses.
In 2020, Inland Real Estate Investment Corp. teamed up with Devon Self Storage with the purpose of redeveloping and operating self storage properties in Qualified Opportunity Zones. The result? One portfolio they purchased together is now generating nearly double the operating cashflow they originally budgeted at the time of acquisition, according to Inland Real Estate Investment Corp. CEO & President Keith Lampi. And this is not the only example that shows the benefits of OZ investing, particularly in the aftermath of the health crisis. But the program is set to expire at the end of 2026, so investors don’t have much time left to act before the tax benefits are eliminated.
In the interview below, Lampi talks about self storage OZ investments and expands on why Inland is so bullish about the sector’s long-term prospects.
Self storage has displayed remarkable resiliency during the past economic downturns. Does this stay true in the current context? If so, why?
Lampi: Yes—while rising interest rates and market volatility have created a unique set of economic headwinds, a myriad of operating trends that present off-setting tailwinds have reinforced the sector’s long-term outlook.
The sector continues to draw from a diverse pool of tenant demand. While a tenant’s reason for renting storage space is wide-ranging, the common theme that connects tenant demand throughout the sector is driven by life events and demographic factors. These demand drivers are often characterized as the four Ds: death, divorce, dislocation and downsizing. Historically, this durability in tenant demand has made the sector far more resilient to economic volatility, and this trendline has held up even in today’s economic environment.
The sector also has strong operating fundaments. Occupancy rates and asking rents—while down from the prior year—remain very healthy when compared to historic norms. We anticipate new supply will begin to taper near term as construction loans are less readily available, which should bode well for mid-and longer-term secular supply-demand dynamics in many markets throughout the U.S.
Also, as the self storage sector continues to institutionalize, the emergence of technology has greatly enhanced operating efficiencies, the client experience, and has helped to mitigate operating expense inflation. Technology has enabled the end-user to remotely monitor belongings, automate bill paying, control temperatures from their phone and utilize extra safeguards including Bluetooth and biometric locks.
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Which were some of Inland’s most successful self storage acquisitions across OZs?
Lampi: Many of Inland’s most successful QOZ self storage acquisitions are retail conversions: vacant retail big box stores in ideal locations, heavily trafficked with excellent visibility which has driven operating performance in terms of rents and occupancy rates. Even though the space is going from retail to self storage, it must still appeal to customers’ desires for visibility and accessibility.
One such recent acquisition was a former K-Mart in Allentown, Pa. This QOZ asset was ideally located with access to Interstate 78 and a mere 2 miles from downtown Allentown, offering 91,787 square feet of 771 climate-controlled units, an interior drive-through and exterior drive-up access with on-site amenities including 24-hour surveillance and electronic gate access. It was delivered in two phases, and in less than a year it is already 60 percent pre-leased in an undersupplied market.
On the stabilized acquisition front, a purchase of note was a 21-store portfolio spanning four states. The portfolio was our first acquisition with Devon Self Storage, who had previously managed the portfolio on behalf of one of their other institutional capital partners. Direct visibility into the portfolio’s operating history of performance provided a unique sightline which guided our underwriting assumptions and the portfolio performed incredibility well out the gate. Most notable, with the emergence of the post-COVID-19 surge in operating performance, the portfolio is now generating nearly double the operating cashflow we originally budgeted at the time of acquisition.
What were some of the challenges you had to overcome when looking to invest in a storage property in an OZ? Were there any opportunities you had to let go as the downsides didn’t offset the benefits?
Lampi: Finding suitable QOZ storage conversion sites are not for the faint of heart, but Inland was successful in finding quality conversion sites given our rigorous search criteria and ability to look for sites on a national basis. From a market perspective, a conversion site had to score well in a multitude of categories, including market saturation and rent levels, demographic profile, traffic counts and competitive landscape. Beyond this, other key factors of the physical site include the building size and footprint, site accessibility, cost basis and exposure and/or proximity to residential users. Former industrial, retail and office properties can exhibit the qualities necessary for a viable storage conversion, and it required an expansive search to find sites that met our criteria.
Challenges can vary depending on the former use of the property, but some of the most prevalent hurdles—that exist even after finding a site that met our criteria—are zoning and environmental. With self storage only more recently being seen as a community amenity, many municipal zoning codes have not been updated to account for self storage or allow much latitude in its use. In addition, many are less familiar with the modern storage concept of a Class A conversion and stigmas can exist preventing zoning code changes or variances to allow a conversion, particularly of former retail sites.
An example of an opportunity which didn’t come to fruition was a former ShopKo in Monona, Wis. The variance was not approved by the local municipality due to a preference for traditional retail use and, as a result, we were unable to move forward with the project.
Do you think OZs have achieved their intended results? How has investor sentiment toward the program evolved since its launch?
Lampi: Yes, seeing underserved markets and assets that have been sitting vacant for many years benefit from capital formation is one of the many upsides of QOZs.
Investor appetite remains, however, industry-wide it has begun to moderate given the looming expiration date of the program’s tax benefits. To put some context behind that statement, according to Novogradac, from 2020 to 2022, more than $9 billion in annual capital formation occurred in the QOZ space. In 2023, we saw industry-wide capital formation decline to $3.5 billion.
With capital inflows down, the market has become far more competitive than it was in prior years. This fact has made the substance behind underlying investment strategy more important than ever and has created a flight-to-quality trend among investors. From an Inland perspective, 2023 was another strong year, with OZ capital collections exceeding what our firm raised in 2022.
What are some of the emerging trends you’re noticing in the sector, and what adjustments are you making in response?
Lampi: It is no secret the self storage sector was a significant benefactor of the post-COVID-19 inflationary environment. It experienced record-level occupancy, rent rate growth and, as a result, operating performance. Now the operating metrics are beginning to normalize.
When evaluating new opportunities, we have always maintained a disciplined and consistent approach to operating assumptions and, as a result, underwriting adjustments have been minimal. Macro-factors such as interest rate volatility and more muted near-term growth has led to a widening in cap rates sector-wide. We pursue all acquisitions with a long-term view in mind and we see this period of dislocation as an incredible opportunity to settle into very attractive basis, when compared to historic norms.
Overall, what are your expectations in terms of transaction activity this year? Are you seeing a shift toward a more buyer-friendly negotiation environment?
Lampi: We expect to see continued softness in terms of self storage transaction volume, at least near-term. Part of this is a function of the friction that exists in the way of buyer and seller psychology. The other component is the robust operating environment the sector has experienced over the past few years, which has limited the number of distressed selling, despite the recent reset. That said, as the market settles into the higher-for-longer interest rate environment, I anticipate the bid-ask differential between buyers and sellers will begin to narrow and, as a result, transaction volumes will eventually rebound.
What are the long-term prospects for the self storage industry as the sector continues to institutionalize?
Lampi: Our firm’s long-term position on the sector remains unchanged. We continue to maintain a bullish outlook on its long-term performance potential, which has demonstrated resilience throughout past market cycles. This view anchors on the belief that its long-term performance outlook will benefit from continued demographic-driven demand and, as a result, the storage sector is significantly less tethered to economic volatility and periods of dislocation. These characteristics have largely propelled the rise in institutional appetite the sector has experienced over the past decade, and I expect this trend to continue in the decade that lies ahead.
