n this opaque environment of low transaction volume, cap rates are not showing much change. Market sentiment shows confidence in the sector, despite protracted expectations on the timing of interest rate cuts by the Fed (most estimating a slight rate cut in Q4 2024). As an example, the average cap rate increased 8 basis points in Q1 2024 over Q4 2023 to 5.83 percent. As of May 28, self-storage REIT stock pricing is showing a trailing 12-month decline of 3.54 percent, but 2024 year to date have declined 12.98 percent. Such a wide variance in range in the public market and low sale activity in the private market suggests investors are waiting for signs of clarity (such as lower interest rates).

We also note a 16 basis point increase to terminal or exit cap rates, suggesting slightly more emphasis to cash flow. Previously, we have seen cash flows weighted 60 percent or more to appreciation. Compressed discount rates remain, showing a small gain of only 3 basis points this quarter. Key performance indicators are shown in the Segmentation by Investment Quality table.

2023 was the year of reversion to the mean or a return to normal after significant COVID and post-COVID gains for the sector, particularly in rents and occupancy. Beginning in the second half of 2022, rate wars began by offering teaser initial rates with significant existing customer rate increases in the 30 percent to 50 percent range. This trend continues with low advertised rates, particularly in markets oriented to institutional investment. It has created some appraisal and credit risk, as underwriters search online and, if unfamiliar with the asset class, can’t reconcile low initial rates to much higher economically stabilized rates of existing customers.

As an example, asking rents declined in 2023 but actual rents continued to increase. An analysis of the asking versus actual rates was put together by Aaron Swerdlin and his team at the Newmark Self Storage Practice from PSA Quarterly and Supplemental Public Filings (summarized in the Public Storage Same-Store Activity chart).

From Q2 2022 to Q3 2023, self-storage rental income growth or actual rents increased 9.8 percent, while street rates or asking declined 18.4 percent. This highlights the importance of understanding the self-storage asset class and is another metric of resiliency, even in a year (2023) of reversion to the mean or adjustment. Simply running an internet search on asking rates provides erroneous results of actual rents. We have analyzed public companies, private portfolios, published resources, completed operator interviews, and reviewed individual assets that have shown a range of ECRIs (existing customer rent increases) from 20 percent to 59 percent on an annual basis with an average of 44 percent (ask to actual rents).

Since Q2 2022, REIT and large national operators began drastically reducing advertised asking rents on the internet, and then applying large increases as shown in the graph by applying existing customer rate increases. This has created a conundrum in valuation modeling for conclusions of market rent. Either ECRIs can be applied to asking rents, or reliance on actual rents is preferred. For stabilized properties, this works well. For properties that are not economically stabilized, two methods can be used: Either forecast market rents at the high end of the range or try to get evidence of actual rents (not published nor available in the sector) or apply significant ECRI rent growth rates during absorption.

However, we note that these reflect top operators with best-in-class technology and algorithms to support robust increases. Our experience in the sector indicates regional and small operators have been achieving annual ECRIs in the 10 to 15 percent range over the past few years, but that data includes post-COVID rate increases. As an example, an examination of a regional portfolio operated privately, comprised of 29 properties in six states, indicates a variance of asking and actual rents of 9 percent in 2023. This demonstrates that ECRIs are trade area specific and can vary widely.

Pricing algorithms in self-storage are complex based on a myriad of dynamic variables. For example, software management packages widely used in self-storage can have as many as 80 settings for pricing. And pricing on any given unit can be changed at any time, 24/7. The impacts of lower internet pricing or “teaser” rates also impacts other variables, such as limited use of concessions and lower advertising costs such as pay per click. Essentially, these variables are bundled into the asking rent (internet pricing or teaser rate) and not used as significantly as separate marketing tools. Therefore, economic occupancy over physical occupancy is emphasized to model algorithms and underscores the importance of the effective gross income of economically stabilized properties.

Self-storage is settling into the new reality of teaser rates and ECRIs. The concept isn’t new (for years one REIT would offer $1 rent first month), but the use of technology and complex pricing models will remain. As the investment market waits on a clear direction and timing on interest rates, transaction volume remains low. As a result, there has not been significant change in investment rates.