Self-Storage - Growing Interest as an Investment Niche
Updated: Aug 12, 2019
Written By David Thompson, Thompson Investing
The model for my real estate business focuses on alternative real estate niches. I want to provide education and investment opportunities for investors to take advantage of the trends and attractive returns some specific niches offer. I carefully select key trusted partners (sponsors) and help provide private equity investor funds to support their projects. In 2016, I spent all of my time learning the apartment investing business, hired a coach, learned how to do market and deal analysis so that I could vet deals before recommending them to my investor clients. I forged a close relationship with Ashcroft Capital and as part of the SEC requirements to market deals, I earned my way into a general sponsor role to help acquire three properties and over 800 units. Out of this grew a strong base of accredited investors that have seen solid performance in these investments to-date. I still like this niche very much and this will remain my focus for my investor base again this year. I expect to do many more deals with Ashcroft Capital as they indicate an active and robust pipeline of potential new projects this year.
In 2017, I wanted to research and get a deep understanding of another potentially solid investment niche. Down the road, this could provide my investors with more opportunities to learn and diversify into some other attractive real estate niches. I identified early on in my research into commercial real estate investing niches, that self-storage was one area that deserved a serious look. I attend a multi-family (multi-unit) meetup group in Austin and although most of the talk is around apartments, I found a small but vocal group involved in self-storage. They talked about how the business model was more attractive than apartments because the CCR (Cash on Cash Return) was higher due to the relatively low cost to operate these sites. That the future looked bright as the growing demand mirrored the growing demand for more folks renting. That had always garnered my attention but I had to admit, it did not seem to be a very sexy niche. I had visions of growing up seeing self-storage somewhat tucked away, out of site, not very attractive, places where folks just stored junk. I also had never paid for one in my life and always thought if I ever came to that point, I have to seriously examine my material life of needs versus wants.
Wow, have times changed. Nearly 1 in 10 Americans is using a self-storage facility today. These facilities are much more visible, clean looking, automated and professionally operated. Sure, the industry is still very fragmented, lots of mom and pop operations and still a lot of leftover, dingy, shed-type looking facilities scattered around, but the big players are taking the game to a new level. No, I’m not using one yet but in my research, I’m finding a lot more reasons why folks are using them. Surely, the increasing demand for renting a storage unit parallels closely with the reasons why I still love apartment investing. Simply, there are powerful trends underlying both types of niches. Demographic trends favor more folks renting and hence, needing places to store their stuff. With home price increases, millennials are renting longer as well. Back in the 70s, first-time home buyers rented only 2.6 years before purchasing their first home, now it's 6 years. But it goes beyond that.
I purchased a new investment home nearby to my home. This was a new home mind you but storage was limited in all the models the builder was building and this was a national builder and a very nice home. The A/C is in the attic and I wanted to show the renter how to replace the filters. We essentially had to crawl on our knees to replace the filter because the ceiling and space was so limited. What’s happening that makes storage an important factor in our lives? More renters I get because millennials often delay buying, and boomers are downsizing. But when folks do buy a home, the builders are not leaving much space in the two-car garage, attics nor inside the home. In many parts of the country like Texas, homes lack basements. Add to this situation stricter rules from the HOAs, and folks can’t store their boat, RV, etc. at home. Many folks are forced to use self-storage beyond just storing excess stuff.
Businesses are also leveraging self-storage like never before. They are finding it cheaper to use self-storage to store offsite—versus taking space in a more expensive office setting—for files, records, equipment, etc. There is an even growing offshoot in building some store-front warehouse space near the front of the self-storage property where there is a lacking availability of business space for those needing a small 400 sf office and a larger warehouse for their storing, staging and shipping operations. I discovered this in Austin when I was looking for similar space with a friend of mine and we both came across the same conclusion: High demand, low supply. I met with a builder and he told me that he found this niche of building a mini warehouse / office for small businesses and is making a killing off just building them and selling them, like 100% return in one year; they’re easy to build and sorely lacking in supply. So, with space, one can add a lot of creative types of storage / revenue streams including simply offering everything from covered and uncovered parking spaces for boats and RVs to full retail operations in the main office where huge markups on locks, boxes, tape, utility hardware, etc. can be offered as a convenience factor to users ready to move into their new storage unit.
Ok, got it. So, what’s the investment angle? Several things were starting to get my attention. In my research for this article, I came across a member of the Forbes 400, Wayne Hughes, who started a company called Public Storage and has a net worth of $2.8B. It must be an industry where one can make serious money I gathered. It’s also a very recession resistant industry. Simply, when the economy is growing as it is now, people buy more stuff to store and when the economy slows, individuals and businesses downsize and store more stuff. Similar to apartment investing using a Class B value-add approach, folks have to live somewhere and offering reasonable rents and nicely renovated properties with excellent management will keep them there through ups and downs. With storage, here is another niche that holds up well during good times and bad and is quite resilient. In 2008 when the economy was getting crushed, the self-storage REITs (publicly traded companies that buy lots of self-storage properties) were the only real estate sector to generate a positive return at 5%. Over 5, 15, 20 and 25 years, these REITs have outperformed the S&P 500 so they clearly have a solid and consistent track record of good performance. Clearly there's something to be said for self-storage investments.
Why is self-storage so attractive from a business model? The cost to build is much less expensive than your typical real estate property as we’re talking concrete, steel frames and garage doors. They’re also inexpensive to operate and maintain (maybe one on-site person, much is automated). Plus, turnover (makeover) costs that are one of the things in apartments that drive-up expenses are almost nil in storage; sweep out the unit, provide a new lock and it’s ready to re-rent. Hence, the breakeven on self-storage is around 45% occupancy level where apartments are about 65%. Tenants are relatively sticky as well, they often move in and never leave. Estimates are that one third of users have stored their stuff in one of these units for over 3 years. Also, the short-term nature of the rentals (month to month) enables owners to turn units quicker and raise rental rates more frequently. This, with the sheer number of units in these facilities, means the owner is not as subject to financial impacts from numerous vacancies hitting at one time. This is another business with scale like apartments that has a very attractive appeal.
Up to 80% of the industry is still in the hands of small independent operators. It's highly fragmented and ripe for consolidation. Many owners have not kept pace with the changing times nor reinvested in modernizing their facilities, expanding their footprint or adding new revenue streams–that’s the opportunity for investing in self-storage. It’s not uncommon to find locations lacking simple signage, websites or other amenities to attract users. Climate controlled, biometric scanning access and other security features are lacking in older properties and becoming more popular. Big players have moved in for sure and five dominate the space but there remains a lot of opportunity for the savvy syndicator looking to find solid, attractive properties that are underperforming. Financing is relatively available and easy to get as the financials and strong history of this resilient sector plays well with lenders.
Further, many cities don’t like new building of storage units as many residents deem them tacky and they don’t create a lot of jobs. That may prevent oversupply in some areas which would be a good thing from an investment standpoint. Research shows that most users want a facility within 3 miles up to 5 miles of where they live. Although data proves most don’t go to the facility as much as they think, psychologically the proximity to their residence is part of the buying decision.
Institutional investor interest is growing towards this niche, as evidenced by a recent article last week in the WSJ that self-storage facilities are getting a serious look. With many real estate sectors seeing slower growth, think brick and mortar retail with the online threat of companies like Amazon and some concerns of rising interest rates, savvy institutional investors (think pension and private equity funds) are in a “risk off” mode. Stable and resilient niche markets like value-add apartments and self-storage that have very favorable long term trends are continuing to gain favor with the smart money crowd.