Is Self-Storage Over Building Catastrophic?
Well, I guess it depends. It depends on where you are in the country, where you are in your submarket, but mostly where you are in your lease-up or ownership cycle of the facility.
Look, it is bound to happen to every industry and every market at some time. That is why you do the underwriting we continually talk about. By definition, the real estate cycle has four parts, and one is called “oversupply”.
Apparently, oversupply now is in most submarkets nine or more sq. ft. of self-storage per capita (some submarkets very some).
It is a natural part of the real estate cycle.
Well, yes, I get that, but is it catastrophic?
Let me tell you the Tale of Two Facilities.
Facility One
Facility One was a conversion that had leased up slightly over the Proforma numbers. Nothing over the top, but very strong and solid.
Its rental rates had been going up much faster than the Proforma. We had enjoyed a 5% to 6% rental rate increases per year, on average, for about four to five years.
Then a number of large facilities hit the market. The project was third-party managed by a REIT, so their philosophy was to get live breathing humans in the facility. They would offer rates 50% of what ours were (I am glad they were not managing mine).
We made the decision, rightly or wrongly, to offer up to one month’s free rent, perhaps reduce rent if needed to close a deal, but no more than 10%.
We felt the integrity of our cash flow was more important than the actual occupancy rate. Good decision?
Our occupancy went from around 95% to its lowest at 83%. It is now running 85% to 87%. But it is our highest per square foot income facility I am involved with.
It was scary watching the move-outs remain constant, but the move in slow down. But we held on, moved slightly on discounts as mentioned above, and focused on what we felt we did right.
Yes, we are not experiencing the 6% per year price increases we had enjoyed, and yes, we are not running 95%, but we are making a good profit that is still a little over what our Proforma indicated all those years ago.
The key here was that (1) we were stabilized when the oversupply hit, and (2) in my opinion focusing on the integrity of the rent per unit and square foot made a difference in the long run there. But remember, we had the luxury of being profitable, and we were not struggling to get to break even.
It’s one thing to be cutting checks to partners that are lower than last year, but to still be cutting checks. Those are one set of conversations.
We adjusted our marketing (i.e., spend more now than we did before), test out lots of different adds and offers, and continually up our online marketing game here.
Facility Two
Facility Two was a different story. It is in the same city, but a different submarket. When the feasibility report was completed, there was plenty of unmet demand.
The only problem was it was a year and a half from the time of the feasibility report to the time of the first unit being rented. During that time, more space hit the market than the feasibility report anticipated (existing facilities expanded). Ours was a ground-up, so it took a while to get the approvals, site work, and construction.
The first few months went great, then bam. Lease up slowed to a crawl.
The only issue here is that we were a long way from break-even between income and expenses and debt. We went through our interest reserve, had a cash call, then went through that.
Unlike facility one, we cut prices in half if we needed. We rented plenty of units, but our big issue was the move-outs. These guys didn’t stay as long because average income was lower here than in facility one, and if the unit’s specials ran out, so did the customers.
We are still not at break even. We are pivoting, adding more parking, and waiting for the market to absorb up. We are most likely going to buy the investors out or move them into another project so we can do what we need to sell or change this deal up to mixed-use or covered boat and RV parking to offer something this market doesn’t have.
Catastrophic?
Well, it depends. At least for us, it depended on where in the project the lease-up was. If you are early in lease-up, not close to breaking even, it can really kill a deal. I have learned my lesson on being clear on assuming anyone who can expand will.
If you are far enough along, it can affect you. Still, if you watch what you are doing and specifically if you can adjust your marketing and show up where the customers are looking (i.e., online), you will survive and eventually even thrive.
Every submarket that is overbuilt will eventually absorb up. That is part of the cycle. I was hoping that with all the data available, that as an industry, we could avoid oversupply in most markets.
I have proven to myself and seen first hand, as a species, I guess we are just not there yet. Humans are going to jump in when they see a good thing, myself included.
In the real estate cycle, oversupply leads to recession. Believe me, for facility two, we are in a recession. That submarket is hurting. Every self-storage facility is affected. It just depends on where they are in their lease up to what degree.
But at some point, even facility two’s submarket will be thriving again. Population growth and a larger percentage of the population using self-storage will solve the problem that submarket is now experiencing.
I am not sure we will be owing to facility two when that happens, but someone will. However, if we don’t own facility one when that submarket is rip-roaring again, it is only because we made a big profit and left to go somewhere else.
The only difference between the two is where we were in lease-up when the market became oversupplied.
Keep your eyes closely on any submarket where you are bringing new space on. Phase in as much as possible, no matter what your contractor or building suppliers tell you. They are not servicing the debt, you are.
