Some self-storage facility owners – particularly those that deal in raising capital in syndications – are trying to proclaim that the Covid-19 pandemic has created a “strong buying opportunity” in storage properties. However, this is simply not the case. Instead, Covid-19 has brought a valuable lesson learned to the storage industry as well as a prediction for the future.
Cap rates were already too compressed in urban markets
Deep down, all storage investors know that recent pricing in larger urban markets was ridiculous and implied rents and occupancy that was not actually attainable. Simply put, the cap rates were way too low. While healthy cap rates in a place like Denver might be 7%, they had been pushed down to 4% or 5%. With interest rates not much lower, the basic problem is that there’s no way to make real money with these properties. When you add in risk factors such as the potential for higher interest rates and property taxes in the years ahead these type of yields just don’t make any sense.
Mass exodus from urban markets spells permanent disaster
You have probably already read articles on what Zillow.com terms “the Great Reshuffling”. Effectively, people are fleeing dense urban markets and moving to suburbs and exurbs. This will spell financial death to many urban storage operators. Reduction in customer counts will lead to higher vacancy, lower rents, and overall lower values at appraisal. In urban markets, storage may be in as much trouble as empty shopping malls – you have to have a large volume of people to make these things work!
Covid-19 has focused damage on luxury properties and areas
Let’s face it, self-storage is a luxury and not a necessity. That $100 per month unit rent typically stores items worth less than the annual expense. When people look at their reduced budgets and are search for things to cut, self-storage will be high up the list. Not only can they save on the unit rent, but they can also get a quick cash infusion from selling their stuff on eBay. There’s really no other way you can spin it. They key users of storage are effectively “rich people” (those with higher discretionary incomes) and this is precisely the group that Covid-19 has whacked.
Mass overbuilding has only created a more dire situation
To make matters worse, there has been significant overbuilding in most U.S. urban markets. Note that Denver is up by 2.7 million square feet. People were worried about this back in 2019 before Covid-19. Think of what the combination of overbuilding and mass exodus from urban markets is going to do occupancy and rents.
Don’t be fooled by price discounts – it’s all about income
If a property that was once valued at $5 million now hits the market at $3 million, that does not mean it’s a good buy. That’s because self-storage is an “income” property. While raw land is based on speculation of future value, storage facilities are valued based on an income approach. If the new income justifies $3 million, then it really doesn’t matter that someone screwed up and paid $5 million a few years ago. Nobody gives out additional credit for historical trivia.
Is there any opportunity out there then in self-storage investing?
So if the urban self-storage market is shot, is there any opportunity left in the storage industry? Yes, but it’s not in the urban core. You want to focus on suburban and exurban markets. This will showcase deals that are smaller and safer, and in markets that have growing population and no overbuilding. Let the REITs and larger storage portfolio owners die in those urban meltdowns – focus on somewhere with a future. And urban markets definitely don’t offer that at this point. I personally think it may take decades to convince those with ideal suburban and exurban lifestyles to risk it all to live in dense, dangerous environs just to be close to the theater again. It will take a long time to erase the memory of the Covid-19 pandemic and urban riots.
Conclusion
Do not let anyone fool you into thinking that Covid-19 is creating a “great buying opportunity”. That’s what silent movie operators claimed when talkies came on the scene. Urban markets, for the moment, are done as far as safe investing. Maybe they’ll come back some decade, but until then focus on somewhere with a future: suburban and exurban markets.