Contrary to what the Biden administration may be telling you, higher inflation is unlikely just a temporary phase. If higher inflation is the new norm for America then how will that impact the self-storage industry? That’s the topic of this Self-Storage University podcast, which will focus on not only the impact but how to mitigate against the risks.
Episode 48: The Impact of 8%+ Inflation Transcript
Contrary to what the Biden administration may be telling you, high inflation, rates of 8%-10%, are not just a blip in the long-term schedule of inflation rates, but more of a permanent fixture right now. In fact, we've pretty much fallen back to the Jimmy Carter era of the 1970s where rates hit as high as over 10%. And you've got to adjust your purchases and your management according to that new higher inflation. This is Frank Rolfe, the Self-Storage University Podcast. We're gonna talk about the impact of high inflation. Now, don't forget that not that long ago, back during the Trump presidency, inflation was not even a non-issue. You never even heard the word. We were producing lots of products, lots of energy, and everything was just seemingly good. And I don't know if you can blame the whole thing on the Biden administration, but clearly, something has now derailed. And out of nowhere, we are facing inflation rates that we have literally not seen as a country for almost half a century. As a result, most people are unfamiliar with the techniques and the issues caused by high inflation, because most self-storage buyers weren't adults during that period.
I, however, was. I was around. I was in business back in the eras of Carter and Reagan, of the battle of high inflation and trying to break the back of high inflation and to cure it. So I'm fairly familiar with it. And I wanna give you some ideas of the impact of high levels of inflation, both the good and the bad. Let's start off with the good impact of high inflation. Well, it erodes your bank loan to real dollars. This is one of the best benefits. And this is why real estate and gold and silver have all done well in inflationary times, because inflation makes the value of the underlying core hard-asset go up. And that makes it inflate in relation to the loan. So if we just continue to raise rents and manage the business, and the values all go up correspondingly, then that makes the loan seem very small. You probably know this if you talk to anyone who ever bought a house or a property in Los Angeles at say in the 1980s or the 1990s. And they bought that duplex for half a million dollars, and today it's worth two million. But when they bought it for half a million, they had 400,000 mortgage, which seemed like a lot back then. But now, it's worth two million, it has a $400,000 mortgage. It looks like a joke.
What happened there? That's the power of inflation on the good side. Another good thing about inflation, high rates of inflation regarding the storage industry is, it's gonna make mortgages very, very expensive. And because mortgages will be very expensive, people will be less likely to move when they need more space. So how do they carve out of their home another bedroom without moving? Well, they're gonna have to put stuff in storage to make way. All the storage in the house is basically gonna go the way of the buffalo and end up in a self-storage, because they're gonna tap into every square-foot they have to add on their own new space needs. Also, that those high levels of inflation are gonna make new homes incredibly expensive to build. You've already seeing that now, lumber prices doubling, and all these different trades and cost and products very, very expensive. And when that happens, again, it puts a premium on what you put on that very expensive square-foot of space in the house. So once again, you're not gonna be storing a Christmas tree on a square feet that might cost you $200, $300, $400 a square-foot to build.
So instead, you're gonna go throw that in a self-storage place and pay a fraction of that. But there are some bad sides to inflation as well. Number one, what it does is, it's going to erode your profitability. Because as your cost as a storage owner go up on such things as electricity and taxes and insurance and management, that's all coming out of something. It's coming right out of your profits. So when you have high levels of inflation, you're gonna see your cost of operation go up right in line with Americans and all the other things that are inflating. Also, very punishing-ly, when interest rates go up, which they will because the inflation is high and interest rates follow inflation, it's gonna raise cap rates. And that's gonna make values go down. So what will happen is, a natural by-product of inflation is higher interest rates, higher cap rates, and that makes all real estate go down in value until you can claw your way back up by raising revenues. Also, it's gonna make borrowing more costly and dangerous. In times of high inflation and higher interest rates, well, that makes your borrowing to buy a self-storage also more expensive, and you can also get stuck. If you borrow the money originally at 5%, and the new interest rate is eight, well, ouch.
That's a big deal. Can you even afford that? And how can you mitigate that? Can you get a fixed interest rate for a long period of time? The bottom line to all of it is, if you're gonna be buying self-storage at this moment, at this time of high, high inflation, and we're only at the start of it. You didn't see inflation as a headline until just recently. It's all been about COVID, COVID, COVID, the last two years. Now suddenly, we move from COVID into inflation, probably being the number one headline in the United States. You can't help but remember it, because every time you go to the gas pump, you're seeing prices that no one has ever seen before, ever in American history. So how do you protect yourself? Well, first thing is, only buy properties with upside. And only buy properties at reasonable cap rates.
If you're running around buying self-storage facilities at a 4% cap rate with no upside, all you're gonna lead to is your own imminent doom. You plan to buy things at reasonable cap rates, or reasonable spread above interest rates, but then also that you can take to the next level. Things that have vacancy to them, or the ability to push rents. Maybe the ability to cut costs. If you buy a park that has no upside in it, it's like buying a bond. And we all know how bonds do in times of high interest rates and inflation. They do just awful. Also, it's very, very important in your selection of where to buy storage that you're in areas where you actually do have the ability to push rents. Those are not going to be in urban centers. People are leaving urban centers. The stats are very clear. People want out of the city, they wanna move in the suburbs and exurbs where life is better, quality of life is higher. And as they make that natural shift as a population, it gives you the ability to actually push rents, and to push occupancy as opposed to defensively having to cut rents and lose occupancies in those urban centers.
So when you're looking at buying, you might wanna focus on properties that are in suburban and exurban markets. Because that's where you'll need to be if you really wanna battle inflation. Bear in mind, that when you are in a period of 8%-10% inflation, just maintain where you are, you would have to, for example, in only five years, increase your revenues by 50% to stay steady with that. You are not, underline, not ever going to pull that off in an urban market. Not going to happen. You're gonna be losing revenue and occupancy more than you'll be gaining. So be very, very careful in your selection. The bottom line to it is, that when you have high inflation and the result in higher interest rates, there's good attributes. There's bad attributes. But the most important thing is to plan accordingly. If you understand the dangers, if you understand the benefits, and you buy only properties that do well under that framework, then and only then can you profit in your self-storage investing. This is Frank Rolfe, the Self-Storage University Podcast. Hope you enjoyed this. Talk to you again soon.