Despite rising loan rates and already-thin acquisition yields, self-storage executives expect that prices will remain relatively firm due to the sector’s robust investor demand and strong operating performance.
Panelists at the New York State Self-Storage Association’s 2022 Investment Forum last week in Tarrytown, N.Y., said the sector is well-positioned to thrive in an inflationary environment because income comes from short-term leases and customer demand is poised to grow because of lifestyle trends.
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“There will be some softening of cap rates, but not as large as it should be given the increase in interest rates,” said Brandon Goetzman, a managing principal at the Blue Vista Equity Group. Goetzman was speaking on a NYSSA panel moderated by event organizer Nick Malagisi, a managing director at SVN Commercial Real Estate Advisors.
Investor demand for self-storage has shot up as institutions such as Blackstone Group, KKR and Inland Real Estate have started to roll up huge portfolios. More than $15 billion of self-storage properties traded in 2021, according to Yardi Matrix, more than double any previous year, while prices hit all-time highs.
The recent spike in interest rates is putting the market to the test. The 10-year Treasury rate, which often is used as a proxy for the “risk-free” rate to price transactions, has increased about 150 basis points since January. That has increased fixed-rate mortgage levels. Earlier in the year, many self-storage property owners could get a fixed-rate loan with a 3 percent to 4 percent coupon, but recently most debt is priced with a coupon between 4 percent to 5.5 percent. Floating-rate loans continue to have lower spreads, but the cost of buying an interest rate cap to limit the impact of rate increases has shot up by some 250 basis points to about 3 percent.
“In a short time, the cost of capital has spiked dramatically,” said Tom Hughes, director at Harrison Street Capital.
Banks are responding to the rising rates by reducing the amount of leverage they are willing to provide. NYSSA panelists said that deals that featured 70 percent loan-to-value ratios are being lowered to 60 percent or 65 percent, and that some transactions have seen high bidders drop out as a result. “Some deals are retraded because the winning bidders are not able to perform,” said Devin Huber, a founder of the BSC Group.
How much impact will the increase in financing costs have on acquisition yields? In order to maintain current pricing levels, investors will either have to cut already-thin premiums over the risk-free rate or underwrite continued large growth in rents.
Christian Sonne, an executive vice president at Newmark, said that in self-storage, the average transaction over the last quarter-century was priced to yield a 3.8 percent premium over the 10-year Treasury bond. More recently, as storage prices have climbed, investors’ premium has been 1.9 percent, about half the long-term rate, Sonne said. “I’ve never seen such compressed spreads,” he said. “Folks are relying on appreciation, not cash flow.”
Yet many in the sector believe that cash flow will keep rising at above-trend levels and prices will remain firm in the face of rising rates. Self-storage rents increased by 10 percent in 2021, per Matrix, as demand skyrocketed due to demographic and lifestyle trends that were exacerbated by the pandemic.
Traditional drivers of demand such as moving or downsizing have expanded to include pandemic-related decluttering and distribution. Individuals working remotely increasingly use storage for home-office-related purposes, and small retailers are more frequently using storage space for distribution. The percentage of households that uses self-storage has grown to more than 10 percent, the highest rate ever, and that percentage is not likely to shrink, industry advocates say.
“The pandemic has created structural growth in self-storage demand,” Sonne said. Investors “believe it is a haven against uncertainty and a hedge against inflation.”