Covid-19 has exposed many weaknesses in certain markets that self-storage facilities serve. But much of this weakness began years earlier when investors practiced the standard behavior of moving with a “herd” mentality. Why is a “herd” mentality dangerous in self-storage investing?
Dangerous investment model
The definition of a “herd” mentality is “a group of people or animals that move in unison in a particular direction”. That’s fine when they are making the right move, but suicidal when there is no greater thought than simply following behind the leader. The top real estate investor in U.S. history is Sam Zell, who has been America’s largest owner of apartments, office buildings and mobile home parks. Zell once said “when everyone is looking right, look left” which meant that probably the worst investment plan is to follow the herd. When they are rounding up cattle to go to slaughter, it’s the ones that run away from the herd that survive. And this fact should not be lost on self-storage investors. The simple fact that investors are hot on a certain market should be fair warning to stay away from it.
The over-pricing issues
When the “herd” descends upon a market, rational pricing goes out the window. Prices soar because of simply supply vs. demand and not based on actual investment criteria like rate of return and net income. We have seen this happen in America in many cycles – both in stocks as well as real estate. You might remember the Dot.Com bubble, the 2007 Great Recession, and even the saga of Bitcoin – all are examples of speculation rather than smart investing. The same is true with self-storage facilities in these “hot” markets that are created by the herd.
The over-development issues
Self-storage has a similar issue with over-development. In recent times, storage developers have gone crazy in following the herd and have built nearly two billion square feet of new storage space in markets that could not rationally support a fraction of that. Each person thought that they had the slightly better location, logo or website, but the truth is that none of these can save a market glut with over-building. If you want to see what the “hot” markets were – and where the herd ran – just look at self-storage articles from a few years ago. You’ll hear about the wonders of Austin, Denver and Los Angeles. You don’t see those articles anymore – now they’re titled “where the rents are falling” and “where the occupancy is terrible”.
How to not follow the herd
The best way not to follow the herd is to follow some simple investment maxims:
- Stick to rates of return. Do not deviate from your original investment goals simply because some idiot tells you “this market is so hot you don’t have to worry about cap rates – it’s just going to go up no matter what”. That’s the mantra of the worst “herd” afficianado (and future bankruptcy case). Instead, look at any storage deal strictly on how it is currently preforming. Remember that this is an income property business, not land speculation. If you want to gamble go to Vegas (after they re-open) but that’s not what smart storage investors do.
- Beware of any place named in an article (unless you already own there). There’s perhaps no greater symbol of a “herd” bubble than a market being listed in articles or on the cover of a magazine. Of course, if you already own a storage property there, then that’s great, as the cap rates will drop and prices will go up regardless of the facility’s net income.
- Always be contrarian and “look left”. It takes a lot of self-confidence to stand up to others who try to sell you on the fact that a “herd”-approved market is the greatest spot on earth. But if you’re trying to make money, you have to be contrarian like that. Acknowledge when a “herd” mentality is taking form, and deliberately stay away from it and look at other markets. You will never be able to reason with those who follow the “herd” so don’t even bother. Let them do their thing and you do yours.
There are many self-storage investors who follow the “herd”. They also never make any money. If that does not sound like your investment style then feel free to be contrarian and follow the money – it’s the actual rate of return and market dynamics that make money.