arket sentiment regarding macro economic conditions are rising, based on expectations of continuing compression in interest rates in 2025. As a result, investor interest in the self-storage asset class remains high. Self-storage is resilient to both inflation and recession and is considered by many market participants to be a safe haven. For example, self-storage has outperformed other core sectors of real estate (such as apartments and industrial property) for an extensive period, according to NAREIT data. This demonstrates confidence in the sector over the long run.
In “Self-Storage Economics and Appraisal,” market conditions is outlined as the core of self-storage economics. It is described as an analysis of the market conditions that affect value using both qualitative and quantitative techniques. One tool, benchmarking, can be a starting point of analysis. For example, a measure of the total self-storage supply per person in the local trade area can be benchmarked to core-based statistical area (CBSA) data published in the Almanac. Another tool, the Cost of Occupancy, can measure rents as a ratio of average household income to CBSA data also published in the Almanac.
Supply data by CBSA comes directly from the proprietary database of Radius+ with known self-storage locations based upon latitude and longitude confirmations. The Radius+ database also includes actual square footage data; therefore, the square footage contained in the Almanac is not reported on a site-specific basis rather than on an industry average.
Determinants of the self-storage market relate to the forces of supply and demand, as is the case with other types of real estate. The analysis of demand generators, however, is focused on four key variables:
- Population,
- The percentage of renters,
- Average household size, and
- Average household income.
A simple econometric model can be used to estimate self-storage demand. Table 13.1 shows the results of regression analysis using a proprietary model. However, this data can be easily duplicated in spreadsheet software or statistical packages. In the multiple regression model, the dependent variable is square feet of self-storage per person. The independent variables are the demographic variables by CBSA: population, percentage of renters, average household size, and average household income. Comparing existing supply to demand can be used as a benchmark to determine if a CBSA is undersupplied, oversupplied, or near equilibrium.
Capital Markets Update
Capital allocators currently find better risk-adjusted returns issuing debt than they do deploying equity into assets or ventures, thus providing opportunity for new debt products to become available, including new self-storage bridge loan programs.
CMBS lending is currently the most constructive its been since 2021; bond buyer demand for favored asset classes like self-storage has increased, leading to tightening spreads, including AAA spreads, which have compressed 100-plus basis points (bps) since Q4 2023.
Finance companies and private credit providers have raised significant amounts of capital and are eager to deploy; pricing is inside of SOFR plus 300 bps, with the ability to push proceeds and provide creative loan structures.
Banks continue to be highly selective with most groups, pushing for partial recourse and/or significant depository relationships; money center banks and regional banks remain closer to the sidelines than foreign banks.
State Of The Transaction Market
Transaction volume was limited in the first quarter of the year, largely due to continued volatility in the debt markets; however, transaction volume is expected to increase into the second half of the year as the trajectory and overall environment of interest rates becomes clearer and the buyer/seller pricing spread narrows from the currently estimated 10 percent to 15 percent.
Long-term investors are biased towards dense, urban markets that have a strong renter population and are less reliant on short-term demand drivers. The decreasing average size of apartments is a long-term tailwind for these markets.
Investors are currently underwriting 3 percent to 3.5 percent average annual revenue growth; however, expect to generate outside growth performance by 2026.
While the transaction market has been muted recently, roughly 30 percent of deals brought to market over the last 12-months have transacted, compared to the long-term norm of closer to 85 percent. The second-quarter activity felt like more deals would cross the finish line.
Given the lack of arms-length transactions, clarity into market pricing and cap rates have been difficult; however, the consensus is indicative of going in rates that range from 5.75 to 8.0 percent depending on the market/submarket dynamics and quality of the asset. Cap rates for most top-50 MSAs are in the 5.75 percent to 6.15 percent range.
Portfolio premiums have narrowed significantly from peak pricing, yet buyers are still willing to pay a premium for a “true” portfolio that has geographic concentration and economies of scale.
Street rates seem to have hit a bottom in Q1, with positive signs for the 2024 leasing season; outliers in certain trade-areas are prevalent where operators are forced to compete with the least-common denominator.
Revenue management systems have become paramount to increasing revenue, with a focus on bifurcating the rent roll into different cohorts to understand market rents and apply efficient revenue management strategies with the ultimate goal of lessening the gap between street and in-place tenant rates.
The sector has benefited from increasing lengths of stay and decreasing tenant churn, indicating higher utilization rates and increased stickiness of the consumer base.
Rising insurance costs have forced owners to pay more attention to the environmental risks associated with certain markets and rethink their overall portfolio composition.
New technologies have not been a source of decreased expenses but have increased customer satisfaction and reduced friction in the overall customer experience.
The coastal markets have been particularly challenged given the difficulty with entitlement processes, elevated construction costs, increasing insurance requirements, and high interest reserves resulting in high carrying costs for developers.
Developers underwriting new deals include a conservative discount to market rents while driving physical occupancy in initial lease-up to provide a safe margin of error in proformas.
While construction costs are up 40 percent to 50 percent since 2017, they are flat year over year.
Land sellers are holding firm on pricing and are willing to outlast the current spike in cap rates, which is leading to an optimistic view on the future of interest rates and subsequent decrease in cap rates.