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18 Mar 2019

Self Storage Investors Start Looking at Smaller Markets to Capture Higher Yields

Self storage investors are being more careful about which assets to bet on, but they continue to be willing to pay top dollar for these properties.

“The buyers are getting much more selective... there has been a lot of continued concern about supply,” says Brandon Karr, first vice president and director of the national self-storage group in the Fort Worth, Texas office of brokerage firm Marcus & Millichap.

Investors are worried about the number of new self storage properties opening across the country.

To avoid competition from new properties coming on-line, many buyers have turned their attention to secondary markets, where fewer new self storage facilities have opened. Meanwhile, buyers in overbuilt markets are taking more time to underwrite their deals, double-checking assumptions about future leasing and rent growth.

Cap rates creep lower

Despite these worries, self storage investors keep paying higher and higher prices for properties relative to income. Cap rates in the sector are at their lowest point on record.

“Cap rates remain at historical lows for cash-flowing and stabilized opportunities,” says Brian Somoza, managing director in the capital markets group of real estate services firm JLL.

Average cap rates inched lower in 2018, creeping closer to 6.0 percent, according to a preliminary estimate from Marcus & Millichap. Cap rates have crept downwards for several years, falling from just over 7.0 percent in 2012.

Investors worry about overbuilding

Developers are planning to open slightly fewer new self storage facilities in 2019 than they opened in 2018, which was the biggest year ever for new construction of self storage properties, according to Marcus & Millichap. Competition from these new properties is likely to push rent growth down.

New construction has generally been quite concentrated, with just five metros receiving 25 percent of the supply over the last three years. That’s another reason many investors are looking at smaller cities to buy properties.

Buyers who are considering properties that are not yet fully leased are likely to assume that it may take longer than usual to lease up, with slower rent growth than usual, if rents grow at all. “Lease-up properties are currently being underwritten more conservatively than in years past,” says Somoza.

“They are getting into the weeds and being careful about how aggressive they are underwriting their future income,” says Karr. “Everywhere you look there is another property being built and how is that going to effect your lease-up timetable?”