One of the main questions that has been posed to appraisers in the self storage industry is how the COVID-19 virus has affected market value. Real estate is an investment type that historically takes a longer period of time to be impacted in relation to alternative investment types.
Based on conversations with multiple market participants, there are several who are taking a “wait and see” approach. It is difficult to forecast the effects both on a near-term and long-term basis. Our opinions and conclusions in our appraisal reports are based on information available and account for market perception as of the date of value in the report.
It is becoming clear that the Coronavirus will have some impact on values moving forward, but to what extent is the question. Unemployment figures climbed significantly across the nation over the last two months. The economic impact will vary depending on property type, class, and location but it is clear that this will directly affect all real estate segments, including the residential market, due to a family’s ability to pay their mortgage or monthly rent.
With over 75% of storage clientele nationwide coming from residential users, initial reaction is rent loss is going to be significant… but has that been the case? Another knee jerk reaction has been that capitalization rates will increase and buyers will demand a price reduction… but have we really seen that?
There are several categories that we feel are important to address when valuing storage facilities at this time, which include Marketing/Exposure Time, Rent Loss, Occupancy, Capitalization Rates, Rent Growth Projections, and Adjustments for Date of Sale. Each of these categories will be described below:
- Marketing/Exposure Time The typical marketing/exposure time over the last couple of years have ranged from 3-4 months; however, considering the current Pandemic and based on conversations with market participants and lenders, we have extended the length of marketing/exposure time to 6-9 months in our reports to account for any delays that might occur.
- Rent Loss We have considered the need to make a short term adjustment to account for the tightening of liquidity and the potential decline in effective income. Our model estimates a temporary rent loss to account for unknown variables. Owners and property management companies are estimating potential rent loss between 5% and 20%, depending on the market and overall location. Market participants anticipated that facilities would get hardest in April, as people were waiting for financial assistance, but that didn’t seem to be the case with several facilities reporting strong collections. Even if you were to estimate a conservative amount for rent loss, assuming a decline over the next several months, it could be considered a minimal (insignificant) amount relative to the overall value of a facility. The table above represents a facility which was valued just south of $10,000,000. Smaller tertiary markets seem to be hit the hardest when it comes to unemployment and rent loss. However, operators can take advantage of government relief programs to cover employee costs and defer debt service payments while tenants recover allowing revenue to remain stable during this time.
- Occupancy The self storage industry is well positioned to get through this current pandemic, similar to the Recession 10+ years ago. As businesses are forced to shut down, many believe they will have a need for leasing storage units to hold on to their valuables. This could lead to a slight bump in occupancy in the upcoming months, which could offset any rent loss. Additionally, numerous facilities have reported that the limited number of new tenants has been off-set by the lack of tenants moving out. In general, the industry has not seeing a decline in occupancy over the last couple months.
- Capitalization Rates Many investors in the industry remain somewhat opportunistic given low interest rates and are actively hunting for deals, while other large owner/operators (REITs) are taking a pause right now. There are several lending institutions that are willing to finance strong assets; however, lenders are taking a harder look at loan-to-value ratios. There will likely be limited transactions, as the spread of value between owner and investor has increased. Active buyers will likely seek a 5%-10% reduction in price to cover near-term income shortfalls and future market uncertainty, while sellers are refusing to offer discounts and are willing to wait it out, believing that rent loss is manageable based on the strength of the industry. There is still strong demand for Class A/B facilities due to the amount of money available in the industry. Here are a couple examples:
- Example – A Class A facility went on the market a few weeks ago in Northern CA and immediately received three strong all cash offers at the listing price. The brokers indicated that there has been no conversation of a reduction due to COVID-19 and they plan to close within the next 3 weeks.
- Example – A Class B facility went on the market approximately two months ago in Southern CA. The subject had multiple offers near the listing price. The owner ultimately selected a local owner who is familiar with the market area. The broker indicated there was no conversation of a reduction due to COVID-19 and they plan to close within the next couple weeks.
Although the potential pool of buyers might be reduced during this “pause” there is still plenty of money in the industry chasing deals due to lack of supply and strong demand. For Class A/B facilities where the implications of COVID-19 appear most temporary, a rent loss adjustment is often more appropriate than an increased cap rate that represents a permanent reduction.
- Rent Growth Projections – In our reports it is common to use both the Direct Capitalization Approach and a Discounted Cash Flow Analysis in the Income Approach. Due to the uncertainty of rent levels moving forward, we have decided to keep rents stable for Year 1 for our DCF, as we anticipate rent growth will be limited as tenants and facilities recover from the Pandemic.
Adjustments for Date of Sale – In appraisal reports we rely on the Sales Approach as a check method to support the Income Approach. Market conditions adjustments are based on a review of historical sale data, market participant interviews, and current versus historical pricing from our research. Self-storage values have appreciated between 2% to 3% over the last several years on a national basis, but the implications of COVID-19 suggest nominal growth in the near term. Furthermore, while there has been a spread between the demand rates for Class A/B and Class C facilities over recent years, with high-quality facilities in primary markets recording the largest annual appreciation, this gap in demand is expected to widen due to the capital available to the respective buyer pools for each class. Therefore, going forward under the implications of COVID-19, specialized local analysis of market demand will be more important than ever when assessing the risk and appeal of the subject investment. Positive growth rates may still be warranted for Class A facilities with the strongest demand, while inferior facilities may require flat or even negative adjustments in some markets.
We are learning that not every sector of real estate is being affected equally during these difficult times. Retail, hospitality, and office have been hit the hardest, while industrial has fared well due to its role in the online supply chain. Multifamily should continue to see demand due to its ability to withstand changes in the economy due to the demand for housing as an essential need. Then there is Storage, which is a niche property type within the industrial ecosystem. Based on the resiliency that was on display in the last Recession, most experts in the self-storage world believe that although this “pause” is inconvenient, the industry as a whole will be just fine.
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