One of the major factors to consider when entering the self storage market, is understanding the end user. Why is there a substantial difference in success between self storage and other real estate? What are the key elements that give self storage the extra edge for surviving tough economic times? The first thing an investor must Understand is what happens to the end user–residential and commercial customers–during the swings in a market’s economy.
During times when a market is experiencing an economic recovery, business begins to thrive, employment opportunities increase and the sales of new and existing single-family homes start to climb. One would expect self storage properties to do well; most often, they do. An evaluation of typical self storage property rent rolls during this time would usually show a high percentage of mobile customers–people moving into the market for the first time or customers “buying up” from starter homes. As the market increases, so does their spending power, which in turn increases the demand for storage of those goods purchased.
On the commercial side, increased business activity means an increased volume of self storage commercial tenants. Conversely, when the economy starts to falter, the same happens to business, employment and real estate in general. However, the reverse effect still causes the same mobility that most often benefits self storage.
People begin moving out of the market or selling their homes and moving into smaller homes or apartments or consolidating households. Commercial businesses downsize or look to self storage for a more economic means for storing inventories as self storage typically leases for less on a per-square foot basis than typical office or retail space. A faltering economy does have a negative impact on self storage, but compared to other commercial real estate, ends to fair better. During downswings in the economy, multifamily occupancies drop as much as 25 percent, while office and retail occupancies drop as much as 25 percent or more. Who are the office and retail tenants? Businesses that have failed or downsized operations typically move to a cheaper property, or move to another market. This is lost income to office and retail properties, and it is not recovered until the market’s economy improves. However, this mobility and need for more affordable space benefits self storage.
Self storage will also have an initial drop in occupancy, which differs from one market to another, but usually averages between 15 percent and 20 percent.
However, a typical average self storage property has a breakeven occupancy rate between 60 percent and 75 percent.
Compare this to leveraged multifamily, office and retail properties with a break-even occupancy rate between 80 percent and 90 percent. Which real estate investment has more room to absorb market declines?
As discussed previously, typically self storage rents fall towards the low end of the range for commercial real estate. This is, in part, due to the relatively low cost to build self storage that require no tenant improvements. Multi-family, office and retail spaces also require constant TI costs at turnover which places further upward pressure on the rents.
It is generally known that self storage rents are slightly below other commercial real estate, but cost a third to half the total development cost of multifamily, office or retail properties. Only industrial development has the potential to be lower. This makes self storage a welcome cost saving alternative to financially strapped end users in a tough economic environment. Conversely, in a stable and growing economy, self storage continues to be space in high demand as businesses expand, consumer buying power increases and more space is needed.
The self storage industry is undoubtedly one of the most stable and reliable investment vehicles available to commercial real estate investors. The low barriers to entry in the self storage industry are a threat, but a topic for another time. See you next quarter. Happy investing!