The self-storage industry for larger owners is much more in peril than what they claim, yet many investors fail to heed the warning signs. In this Self-Storage University podcast we’re going to review why most large U.S. operators are in big trouble and how to learn from their mistakes.
Episode 127: Smoke, Mirrors And The Achilles Heel Of Large Storage Operators Transcript
If you read the PR releases of most of your American self-storage REITs, you would think that things are going great. I looked at one from public storage recently, and it talked glowingly how they were having increases in revenue and increases in net income. But then I dug a little deeper in it, and I found that most of those increases were due to acquisitions. But in fact, the core properties had declined a little bit in revenue, from what I saw, and also declined a bit in net income. So from one year to the next year, it wasn't the rosy scenario that was being painted, but something a little more dangerous. This is Frank Rolfe with the Self-Storage University podcast. We're going to talk about how some of these big companies have been hiding their misfortune with smoke and mirrors. The lessons learned from that, and how to not be a part of that problem. So, in the case of public storage, which is the largest of all self-storage REITs, they've done a masterful job of building their business and great jobs in public relations. They're probably, when it comes to self-storage, the industry leader by far.
But the issue you have when you start reading through a lot of these financial documents of many of these REITs, is the numbers just don't make a whole lot of common sense. Let me give you an example. Public storage's stock is currently valued, from what I saw, at around a P/E ratio, price-to-earnings ratio, of 28. Now, public storage is not building electric cars. It's not building iPhones. So, where will the growth come from to bring that P/E ratio back in line with regular real estate? Because at a 10% cap rate, a P/E ratio, a price-to-earnings ratio, would be at 10. 10 times the net income would be the value. At a 5% cap rate, it would be 20. Now, we're probably past the moment in the storage industry where 5 cap rates ever going to be realistic. But even then, that's only at 20. But they're closer to 30. That would equate to a price-to-earnings ratio of about a 33% cap rate, which at best is half of prevailing values. How did it get so out of whack, you might say? How in the world could real estate be valued the same as consumer products that aren't tied to income like that?
Well, it's a good question. When you look over the stocks of things like Tesla, for example, it's a real head-scratcher. It doesn't make even an iota of the income necessary to support the value of the stock. But someone who's a huge Elon Musk fan would say, well, you're not thinking about it realistically because Musk is a genius. And even though Tesla cars aren't selling well at the moment or making any money, we're going to be bailed out because he's going to come up with some kind of concept of a robot or the self-driving car, things like that. And that's what keeps the stock always up, is this warm, fuzzy feeling that there's some kind of other product coming down the road. But in the case of self-storage, there's no other product going down the road. It's basically just a storage unit. There are no great ideas will spring forth. No one's going to launch a rocket ship using self-storage technology. So there really isn't that end-of-the-rainbow thing when it comes to stock valuations. Now, will the stock remain at current levels? I don't know. I'm not a stock analyst. I don't follow public storage or any of the storage REITs.
But to me, I would be concerned when you look at the values, how they actually tie back. If you were to take the net income of one of the storage operators on their quarterly report, multiply that times four so you have an annualized, and then cap that number at the prevailing cap rate, subtract the debt, that would then tell you how much owner's equity remains. Divide that through by the number of shares, and now you would have a true picture of what the value would be. I don't know if any of the REITs, based on that common sense way of evaluation, would work. So how did they get there? How did a lot of these storage REITs no longer offer the kind of growing, booming business that they once did? To me personally, I think the big problem with the storage industry today comes down to two components, which to me are the two big lessons learned for anyone wanting to invest going forward. Problem number one, nobody likes self-storage if you cannot back up your car to the door of the unit. I've never been a fan of multi-story self-storage. I've never really understood it.
I've never seen a consumer who would choose a multi-story storage situation where you have to go in and cart all your stuff on a two-wheeler in an elevator to get to your unit, who wouldn't prefer just the simplicity of pulling it up and getting it out of the car. So I think the first problem you have with a lot of the REITs is when they started to design a product that the consumer didn't want but that they liked. It was much easier for them to make sense of building and buying property in more expensive areas when they could go up multi-stories. But that wasn't based on consumer demand. That was based on their need to try to rationalize the pricing. That was problem number one. Problem number two is they made huge bets on America and they were proven to be wrong. A lot of the storage operators elected to put all their eggs in one basket and that one basket was urban. They put all of their money, all their facilities, all their growth into heavy in the center of town locations. That's where Americans are leaving. Even some of the city choices of a lot of the storage operators were in the end not the brightest.
Heavy concentrations in urban California and other states have proven now to be on the wrong side of the curve. Americans today are pushing farther out. They're seeking areas where they have lower density. Look at what happened with In-N-Out Burger, a staple of California. The owner of In-N-Out announced that she and her entire family are moving to Franklin, Tennessee. How is that even possible, you might say? In-N-Out? That's a California thing. Well, she said that it was so difficult doing business in California and so difficult to raise families so they would be well adjusted in California that she was giving up and basically moving to a small town in Tennessee. It's about an hour south of Nashville. That's how things are progressing. If you like, go online and look up U-Haul's one-way rentals. That's always been a good way to see where the American population is going. If you look at those one-way rentals, you'll see two shocking developments. Number one, people are all moving out of big cities to small town. Rule number two, they're all moving out of the West and the Northeast down to the South and the Southeast.
So those big bets people took on areas that at one time appeared hot, well, they doubled down and maybe bet too far and rather than diversify so they had a safer playing field, they bet the farm on one thing and it appears to not have been the winner. If you're going to succeed in self-storage going forward, you need to focus on doing the reverse of what a lot of the large companies are. You need to focus on, number one, more rural areas, suburbia, exurbia, super commuter, where the people are going. They want to get away from urban cores. Don't focus on downtown. Focus on pushing farther out. There's less supply farther out. There's less potential for supply farther out and that's where the consumers are going.
Number two, don't focus on anything that you cannot pull your car up and take the storage stuff out of your trunk or out of your pickup truck and throw it right in your unit. That's what people want. When I look at facilities that are completely full, ones that have waiting lists, I've never seen one full with a waiting list that was not one with exterior doors, you roll right up and it was in a suburban or exurban location. That's where the growth is today. Now, will the wreaths be able to change course and adapt their business model? I doubt it. They've been around a long time. They're very set in their ways. They would never want to admit their mistake, so they'll go on continuing to do the best PR news releases they can do. But for everybody else, if you're trying to get into self-storage and actually make money with it, don't mirror what the big guys are doing. Do it the right way. This is Frank Rolfe of the Self-Storage University podcast. Hope you enjoyed this. Talk to you again soon.