I have worked with several self-storage investors who are now considering and undertaking mixed-use projects of self-storage and flex space.
Flex space is the new shiny object for many smaller self-storage developers.
As strange as it may sound, I worked for a development company as a Broker in the late 1980s and early 1990s that built a lot of flex space.
You may hear it called office/warehouse, small bay, or flex space.
We are now trying to put together a development plan for a project with flex, boat, and RV space.
There are many similarities to self-storage, but also many differences.
Let’s discuss the pros and cons of flex space as I see it in the first quarter of 2025.
Also, this has been a fantastic year in NFL football.
We are headed to the playoffs as I write this.
Let’s have a play-off between self-storage and flex space.
Let’s score the two in the Storage vs Flex Space Q1 2025 Match Up!
Let’s Meet The Teams
The self-storage team you are well familiar with.
Team Storage is stabilized and has all the benefits of self-storage as we will score in the match and compare them to Team Flex in our play-off.
This could be a recently completed expansion, conversion, or ground-up development.
You may not be as familiar with the Flex team.
Some of the things attracting many self-storage operators to the space are the similarity of construction, the fact that using dynamic pricing, storage rates are everywhere, and flex can perhaps stabilize the cash flow of a project. Many of the customers for both appear to be the same or similar, and the fact flex can potentially offer NNN income.
Also, in markets like Florida, where industrial land is not being made every day and is tight, rates can be quite high.
In most of the rest of the country, one can expect, let’s say, $8 on the low end to perhaps $16 or so on the high end. Every market is different.
I have paid more attention to this asset class than I have in years. In two of the partnerships I am in, they are considering doing flex projects.
So, let’s compare the two.
No, let’s have a match. It’s playoff time in the NFL, so let’s have a playoff between these two asset classes.
First Quarter of Game
So, in the opening drive, as we look at storage as an asset class, it has a lot of real benefits that initially attracted us to it.
Construction cost for single-story self-storage is still less than most any other real estate asset classes, including flex space.
Today, I can build a single storage drive up for about $75 per square foot to $85, not including land cost, holding cost, and soft cost.
Flex space, depending on how much office is included, would be at $130 to $160 for comparable quality.
I am assuming a metal building, with 10% to 15% or so office, drive-in door in front or rear. Glass front like a strip center, or some upgraded front to the building. Basic but nice.
Also, flex is a true real estate play. You have leases and a landlord-tenant relationship with your tenants.
You must evict for non-payment. No auctions.
One would also most likely have to hire a real estate agent to find the tenants, and you would pay a commission.
There is a bathroom and some office, which over time will need some repair and upgrade, although much less than apartments or rental houses.
You may also have to pay a renewal fee to an agent if the tenant renews their lease.
So, in the opening drive, I say self-storage scores and gets the extra point.
But that was just the opening drive.
Today, in many markets, self-storage is overbuilt.
Many self-storage operators have a site or markets they want to be in and find it hard to justify more self-storage.
In many markets, building, let’s say, 30,000 square feet of flex space will lease up faster and have more demand than another 30,000 square feet of self-storage.
I have seen some developers start with flex space and then slowly add self-storage until the lease slows down.
Yes, it may not have all the initial benefits of self-storage that drew us to it in the first place, but in most markets, flex is not as overbuilt as self-storage.
That’s a touchdown in my opinion for flex in this first quarter of the game taking place in Q1 2025.
Second Quarter Of The Game
So, we are moving on now, and it will be tied up as we end the first quarter.
Let’s look at income.
It’s really hard to compare per-square-foot incomes to each other because there is such a wide range for each, depending on which market you are looking at.
Also, for self-storage, if one is in a market where there are REITs and sophisticated owners, today’s dynamic pricing adds to the difficulty of scoring.
In the late teens of this century, dynamic pricing was raising rents at record levels.
Today, it is the opposite (at least for many markets’ entry rates for customers). Most of the markets I am in have dynamic pricing, so it is hard today to really underwrite what we can expect rents to be for the next 12 months or so.
Over time, a 3% to 5% per year price increase is realistic in my opinion. However, in the immediate future, I see self-storage rental rates flat or rising slowly.
That is why some self-storage operators are looking to flex space today.
One usually has a three-to-five-year lease with a fixed rental rate indexed to something like CPI (although there now might be a cap on the CPI increase, like 3% to 5% per year). I usually see rents going up yearly or every two to three years.
Today’s stability of this rent attracts some storage investors, although one’s rental rate upside is usually fixed and in the lease.
On this drive down the field, team flex gets a field goal (3 points) for this feature in quarter 1 of 2025 with storage rents in flux from dynamic pricing.
Now, Team Flex kicks off, and Team Storage is on a drive downfield.
What I see is that over the long run, the flexibility of self-storage rents will allow the rent to rise, in most cases, much more than in flex space.
However, the real difference is the tenant base.
I have heard many say that the tenant base is much like self-storage. But is it really?
Not in my experience.
Flex is like a B-to-B business. My experience is that almost all tenants are smaller, local companies that provide a service, like plumbers, window replacement, siding, electrical, sign companies, and the like.
Often, the owner got tired of working for someone else and took their skills and started their own company.
They, in essence, create jobs where they are the employer and often have little or no business background.
When recessions hit or hard times come, their companies are usually the first to fold.
Not all of them, but many do, from my experience.
Self-storage usually has 20% or fewer “commercial customers.” Storage is more of a B-to-C (business-to-consumer) operation.
Our client base is driven by changes in one’s life, death, divorce, death, etc.
Boom times in the economy and down times in the economy both create the type of changes that can create storage demand.
So I see that not only in the long run will storage rents most likely go up more (i.e., creating more value for the asset), but the income stream will most likely be more stable over the long run.
Clearly, a goal and an extra point as we reach halftime.
On any given Sunday, any team can win in the NFL.
In different parts of the real estate cycle, any given asset class can win in the game of investment real estate.
This is a close game now, and let’s see who may win (as I see it) in the first quarter of 2025.
Third Quarter Of The Game
Team Flex is the receiving team as we start the second half of the match.
Let’s discuss operating expenses.
Operating expenses, especially insurance, have gone up quite a bit for self-storage and all asset classes over the past few years due primarily to climate change.
The real art of creating wealth is to have your income as a percentage going up more than your operating expenses as a percentage.
In self-storage, with rents often tied to dynamic pricing, at least for the first few months of a customer’s time in a facility and rent growth being slower now than in past years, the next few years may be hard to have income increasing over operating expenses as a percentage.
In most flex space situations I have ever been involved in, there is usually a Cam (common area maintenance) fee paid by tenants on top of their base rent that passes all or most of the operating expenses through to the tenants based on their percent of occupancy of the building.
Not all markets have this practice, but any I have ever been involved in do.
So, in other words, the base rent is the net operating income (NOI) or close to it in most cases.
IN QUARTER 1 OF 2025, THIS IS CLEARLY A GOAL AND EXTRA POINT FOR TEAM FLEX.
So Team Flex is kicking off to Team Storage after this long drive, which ended in a touchdown and an extra point.
Team Storage is slowly driving downfield again in the latter part of this third quarter of the game.
What all know is that NOI growth is what really increases the value of assets.
Over time, no asset class has more dials and levers that operators can pull to increase NOI.
Tenant insurance is a good example. When we purchase a mom-and-pop asset and institute tenant insurance, we could increase the NOI by as much as $15,000 to $18,000 for a 50,000 to 60,000-square-foot facility.
At a 6.5% CAP rate, that equates to a $230,800 to $276,900 increase in value from this tenant insurance add-on alone.
There are all kinds of other income dials and revenue strategies that are just not available in Flex.
This may not make a big difference over the next year or so, but in the long run, it’s huge. The ability to tweak when rents go up, add other income streams, as well as the ability to work on reducing operating expenses, will count for a field goal (3 points towards the end of the third quarter of our match.
Forth Quarter Of The Game
Close game in the q1 of 2025.
But one team is about to really dominate the rest of the game, I think.
We have talked about demand, income, expenses, and the ability to increase NOI…now let’s talk exit strategies.
This is a critical piece of the ownership journey.
My experience is there are many more institutional buyers, funds, REITs, and large syndicators in the storage space looking for deals than in the flex space.
I generally see CAP rates lower for self-storage than flex space.
Much of the higher CAP rates ( usually .5% to 1.5%) for flex is a function of the tenant base, mostly small, often start-up, mostly local companies.
My best guess is that no matter where in the real estate cycle we may be, self-storage cash flow will trade at a lower CAP rate than flex. In other words, if both flex and storage had a $500,000 NOI, the self-storage would trade at a higher sales price to a ready, willing, and able buyer than a flex space would with the exact same NOI.
Touchdown! Extra point!
Game over (for now).
Keep this in mind as you explore self-storage and/or flex space this year.
Close match, but my bias is clearly showing through. I love the storage business and feel safer here than in any asset class there is, even with the current challenges.
The reality is there are always challenges. That is one of the things that makes playing the game so worth it.
Enjoy the NFL playoffs this year.
