The latest industry data suggests that new supply is creating some strong crosswinds that could hinder the self-storage industry – at least in the near term.
Although last year likely represented the peak in construction activity for this cycle, there is still a robust pipeline of projects still in the works.
“Rather than a peak and valley with new supply dropping off quickly, we’re seeing more of a plateau where 2020, 2021 and 2022 will just slightly taper off,” says Chris Nebenzahl, institutional research manager at Yardi Matrix.
A big pipeline
Nationally, there will be an estimated 825 new projects totaling about 56 million square feet coming to market this year when including new ground-up construction, conversions and expansion at existing facilities, according to a new market forecast released by Yardi.
The firm is predicting that deliveries will decline only slightly to 54 million square feet in 2020, followed by 51 million square feet in 2021 and 49 million square feet in 2022.
In its second half market update, Marcus & Millichap also predicted that new supply will moderate. The firm anticipates that completions will drop from 65.8 million last year to 60 million square feet. However, that is still a hefty load of new supply that represents a 3.9% expansion of inventory – the second highest growth rate so far this cycle.
Rents are under pressure
Generally, it will be a “tough slog” ahead for owners given the amount of new supply that has been delivered and is still on its way, says Nebenzahl. Increased competition is fueling more concessions and driving down street rates in most markets nationwide.
According to Yardi, street rents were negative in most markets last year. Although that picture has improved somewhat in 2019, Yardi noted that only eight of the top 30 markets were reporting positive rent growth as of July.
One theme that is becoming more common is that street rates have definitely declined over the past two years, agrees Aaron Swerdlin, a vice chairman at Newmark Knight Frank in Houston. The question is what is the new stabilized street rate, and are there markets where those rates have reset to a lower level?
“I don’t think we know yet, because I don’t think we have completed enough of this cycle,” he says.
Yet despite the challenges that exist at a macro level, self-storage remains a very micro market business that is especially focused on the 3 to 5-mile radius around a facility.
“There is certainly an elevated level of competition in many places and it is the number one topic on everybody’s mind when they are analyzing a situation,” says Swerdlin. “But I don’t think you can make the statement that the entire industry is challenged from new competition.”
Investors proceed cautiously
Buyers are proceeding cautiously and doing more due diligence and analysis on investment opportunities. However, there is still a lot of capital that is interested in self-storage.
“I still think if you have core real estate in a top 10 MSA, unless you are absolutely browbeaten by new competition, the market is deep for those deals as it’s ever been,” says Swerdlin.
Investors also are more focused on cash-flowing deals, while the sale market is more challenging for non-stabilized properties, he adds.
According to Yardi, the influx of institutional capital and strength of NOI is helping to keep pressure on pricing. The latest data through July shows that property sale prices rose 5.1% year-over-year.
“One of the unique aspects of this asset class is that you still have growing NOI in the face of this supply pressure,” says Jeff Adler, a vice president at Yardi Matrix. “So, the sector definitely has the characteristics of a defensive sector that can absorb this supply pressure,” he says.
Investors and developers alike are digging in to find pockets of opportunity. Demand is strong, but it is shifting more to the lower cost cities and secondary markets and away from the gateway markets, notes Nebenzahl. In particular, the South, Southeast and Southwest all continue to see good demand growth, in large part due to job and population growth in those regions.
Other opportunities exist in tech hub markets, as an example, as well as markets that have typically had low penetration, such as Chicago and San Francisco that have a lot of regulatory barriers, he adds.