Institutional Capital to Keep Cap Rates Low in Self Storage: Q&A
Due to high occupancy and low interest rates, the US self storage market has seen an influx of institutional capital in the past couple of years. These strong fundamentals fueled unprecedented rent increases, and continues to boost the sector’s appeal.
Multi-Housing News sat down with Brandon Goetzman, managing principal & co-head of Blue Vistato find out why self storage will remain an attractive asset class to invest in, despite new challenges on the horizon as the Federal Reserve begins a tightening cycle.
READ ALSO: Why Self Storage’s Slowing Rent Growth Is Not a Concern
We’re at the two-year mark of the pandemic. How has the deal environment evolved for self storage investors since the onset of the health crisis?
Goetzman: There was a cloud of uncertainty around self storage at the onset of the pandemic with a meaningful drop in advertised rental rates during the shutdowns that occurred over the first few months of the pandemic. The gradual reopening that occurred in June of 2020 resulted in a surge of demand for self storage, proving the resiliency of the asset class.
This resiliency, coupled with low interest rates, resulted in an influx of institutional capital into the storage sector, which drove cap rates to new lows. Institutional investors recognized the combination of recession resistance, low on-going cap ex and the potential for upside in growing rental rates created a lot of competition from new investors in the space, particularly for existing self storage assets.
Blue Vista has been focused on finding off-market, value-add acquisition opportunities and also developing new self storage projects with a focus on markets with meaningful population growth and limited existing Class A self storage supply. We think that these strategies will continue to generate strong returns for our investors.
Where do you see most self storage deals happen? What markets are institutional buyers interested in?
Goetzman: Self storage assets are in demand throughout the country, but institutional investors are focused particularly on well-located assets built in the last 10 to 15 years in markets experiencing population growth.
Blue Vista has been developing new, Class A self storage assets since 2016, with a focus on high growth secondary markets in the Southeast and Southwest. Projects in these regions have delivered fast lease ups due to tailwinds from population growth and employment growth.
Please talk about the top three trends in self storage financing.
Goetzman: Since the onset of the pandemic, industrial and multifamily became the darling commercial real estate property types for many lenders as there were concerns with other commercial property types impacted.
Self storage should clearly fall into the same category as industrial and multifamily, and many lenders recognized this over the last two years and have been increasing their exposures to self storage.
This has helped drive access to capital to the asset class, assisting investors with cheaper access to debt capital. The market is anticipating a meaningful move up in floating rate debt as the Federal Reserve begins a tightening cycle. This will increase debt financing costs for self storage in the near term, particularly for floating rate financing.
Blue Vista has also identified more access to construction financing for new self storage projects—given the strength of demand from tenants—and also the liquidity of stabilized self storage projects.
Looking at storage construction financing, have you noticed any specific factors lenders and borrowers consider more in the current economic context?
Goetzman: The number of new self storage projects being built across the US is nearly at an all-time high. The new supply will eventually have an impact on rents and occupancies, particularly in submarkets with higher levels of existing self storage relative to population.
I think the savviest lenders and investors are being more cautious of potential competition from new supply. Having multiple new self storage projects delivered around the same timeframe can result in a meaningful decline in rental rates for all properties in the submarket, at least until the new projects stabilize.
READ ALSO: Here’s Why Self Storage Will Continue to Prosper in 2022
What should self storage lenders keep an eye on in the coming quarters?
Goetzman: This has been a “rising tide” market since summer of 2020. The self storage industry is near peak occupancy and coming off a period of significant rent growth since the beginning of the pandemic. With additional new development deliveries likely to increase over the next several quarters and in 2023, the supply and demand dynamics of individual submarkets will be more important going forward and will drive occupancy, absorption and continued rental rate growth.
Despite all these potential challenges, do you expect high investment activity to continue across the country this year?
Goetzman: Self storage investment activity will continue in 2022 because the reasons that attracted new institutional investors to this property type over the last several years still exist—low ongoing cap ex needs, ongoing demand tailwinds particularly in markets with population growth, very attractive NOI operating margins , attractive debt financing and perceived recession resistance of the property type.
What trends do you think will impact the industry in 2022?
Goetzman: Continued cost inflation of development inputs from labor, steel and debt financing will be a key determinant as to whether the development pipeline can remain as robust as it is today.
Furthermore, higher financing costs—a reality for all self storage investors—could slow or even reverse the record low cap rate trends we have seen over the last two years.
Regardless, we still expect that self storage cap rates will remain meaningfully lower than where they were pre-pandemic because of the number of institutional investors that are actively deploying capital into this sector. We expect that it will continue to be an attractive time to be a self storage investor in the coming years.