Story originally on Sparefoot.com
InSite Property Group is a multifaceted real estate investment group with 25 development deals in place across the country—22 of them are self-storage.
It operates its storage facilities under the name SecureSpace. The firm has completed and opened three so far, the latest is a 75,000 net rentable square foot facility in Camarillo, CA with 600 units. The project has an equal amount of office space for rent on the second floor. It has also opened projects in Titusville, FL and Piscataway, NJ.
Based in Redondo Beach, CA, InSite was established by Paul Brown and Zack Linford, who were previously partners of iStorage. That company sold its 66-facility portfolio to National Storage Affiliates for $630 million in 2016. Subsequently, Brown, Linford, and a small group of new partners joined forces with a large institutional investor with $90 billion in assets to start InSite Property Group.
SpareFoot recently spoke with Keith Wetzel, one of InSite’s partners who leads acquisition and capital raising efforts. Before joining InSite, Wetzel was Managing Director and Head of West Coast Real Estate at Goldman Sachs. Joining the conversation was Nathan McElmurry, who was recently hired as Head of Self Storage Acquistions. McElmurry was previously Senior Vice President of Acquisitions for SmartStop Self Storage.
While InSite has exclusively operated as a developer over the last two years, the addition of McElmurry to the team marks a new chapter for the firm as it embarks on strategy of acquisitions to grow its portfolio of storage facilities.
Nathan, as you lead the charge for acquisitions, what type of properties are you looking for?
Nathan McElmurry: You will see me buying existing product across the spectrum—anything from C of O on up to fully stabilized properties.
When it comes to size, the biggest determinant is revenue. If a stable property is generating less than $600,000 to $700,000 of gross revenue, or a lease-up won’t reach at least $800,000 to $900,000 at stabilization, it’s probably too small for us. In the case of stable assets, these small stores become inefficient to manage, and in the case of smallish lease-ups the carry costs weigh us down disproportionate to value. So either way, the lower-cashflow stores are dilutive to a portfolio.
Are their specific markets you are focused on?
Nathan: You will tend to see us clustering existing acquisitions around our ground-up developments for economies of scale. But ultimately, for geography, it is really more about our theory of where to buy when. What I mean by that is there are certain places where, if you can snag a property at something close to a tolerable price, you will generally do it because these locations can’t be replicated. Examples would be gateway cities such as New York and L.A.
There are other markets, like Nashville, Charlotte, Houston, Portland, and others, which are in various stages of having been overbuilt. For those areas it’s more of a timing thing. We’re comfortable with overbuilt markets where some of the dust is starting to settle regarding winners and losers.
When you say you are comfortable with overbuilt markets, what do you mean?
Nathan: We don’t want to be the owner of a 10% leased building in a market that has 5 other stores nearby in lease-up or under construction and other folks have pulled permits to build. That’s not something any responsible buyer should pursue. But there are other markets which are overbuilt where new building has largely ceased, and the winners and losers are starting to emerge. You can look at the graphs where you see supply that has been delivered vs supply coming online in the future and it is kind of telling.
Can you give an example?
Nathan: Take Houston for example. They had an oil bust in 2015 and are having another one now. Back in 2015 they were already overbuilt, and they are still working through that supply. But no one is really intent on breaking new ground in Houston. So, an area like the Woodlands in north Houston, which had at least a half dozen stores built in the last 5 years on top of the existing supply, has now begun to sort itself out. The rents are stabilizing. The problem isn’t solved, it’s still overbuilt. It is still in lease up, but you can underwrite to it. Some overbuilt markets we can underwrite credibly, and some we cannot because the supply impacts are still very nascent.
Are you finding it harder to find properties that meet your investment criteria?
Nathan: Historically, I used to be able to buy somewhere between 7% to 8% of what I saw. Now that number is 2% to 3%; it’s that hard to find the right properties.
Is that due to COVID-19 or something that was happening before?
Nathan: That drop down is really pre-COVID; good acquisitions had already become difficult to find. But we are optimistic that we’ve hit a bit of a reset button and will be able to increase our volume. There are already a number of assets which have come back around under more reasonable terms. Not a tidal wave by any stretch, but we are seeing deals that we are already familiar with and would have been happy owning before but the price was too high. Some folks now at least are willing to have the discussion.
What is the typical deal size for the properties you are looking at?
Nathan: On the acquisition side the average deal size five years ago was $7 million to $9 million. Now it’s $10 million to $12 million for the kind of stuff I look at. That’s a reflection of higher rents, cap rate compression and the fact that most of the new supply sells at a higher per square foot basis than older stock. But, again, that’s merely an average and we truly do look at everything that comes across our desk.
What is the goal? Number per year?
Nathan: As many as we can. I left a firm that built up their portfolio, sold to Extra Space for $1.4 billion in 2015, and when I left a month ago it was back up to bigger and badder than before – and with a really high quality portfolio. The goal here is to do the same and we have the firepower behind us to do it. If we don’t succeed on this front I would consider my efforts a failure.
What promoted InSite to make a turn towards acquisitions to begin with?
Keith Wetzel: When we set up InSite and SecureSpace in 2018, we had a concerted effort to enter storage through development. The market on the existing side had become really expensive and the risk adjusted return was imbalanced. We focused on development and we believed we could achieve more attractive returns vs buying existing storage properties. About six months ago, we had the view in 18-24 months there would be a big opportunity in the C of O and lease up space because of the increase in supply we have seen over the past few years. We thought some markets were really oversupplied and a lot of equity sponsors and banks would become impatient from under performance.
How has COVID-19 impacted that outlook?
Keith: We now believe COVID-19 has brought forward the pressure we expected to see and sellers are testing and re-testing the market at lower price expectations. We are very fortunate to have Nathan on board now to take advantage of this opportunity.
How will the new acquisition focus affect InSite’s development program?
Keith: We’re not slowing down our development.As Nathan was saying before on the development side, our geographic focus has been ultra-high barrier to entry markets that are difficult to develop and build in.
How have your new stores fared in the current environment?
Keith: We pride ourselves on leveraging technology to innovate in storage. We are really fortunate that pre-COVID we built a system to do contact free move-ins and our existing stores are well ahead of our initial lease-up projections.
Have we moved from a seller’s market for self-storage to a buyer’s market?
Nathan: To some extent COVID-19 did, overnight, what needed to, and was going to, happen anyways. The acquisition market had reached the frothy stage and all rising markets eventually end. But it happened faster than anybody thought. Some degree of shock has taken place not only in our niche, but across the whole commercial real estate universe. Folks know they can’t get the pricing they used to, but they haven’t quite started to settle at a lower number. It’s a buyers’ market in theory, but we don’t yet have a material volume of sales data to point to and say it’s actually dropped.