Is there really a slowdown in the self storage space due to rising interest rates?
There appears to be, but for me, at least, the total picture isn’t quite in yet.
Like our world today, the self storage industry is a mixed bag of contradictions.
As small investors, our job is to navigate these seeming contradictions and develop strategies to get into self storage or grow our existing self storage businesses.
Yes, I have had some deals fall out because of the interest rate hike and changing economy.
Many big real estate firms like Marcus & Millichap and Cushman Wakefield report fewer buyers out there (a good thing, in my opinion), and CAP rates are slightly higher.
I haven’t been able to get definitive data yet on CAP rates in storage sales for the 3rd quarter of 2022, but I see higher CAP rates in some of the offerings (again, another good thing in my book).
Here is a quote from a WealthManagement.com article about self storage:
“Instead of 20 offers for a property, there are now seven,” says Anthony Piscitelli, senior vice president of investments at Arcland, based in Washington, D.C.
And,
“Fully-stabilized properties in top metropolitan statistical areas continue to draw strong interest,” says Skyview’s Schoettlin. “Secondary and tertiary market deals, early lease-up, and ‘certificate of occupancy’ deals are still seeing interest but typically have fewer bidders than what we saw at the peak.”
In my case, the deals I worked on that fell out of contract were ones we underwrote when interest rates were lower.
Since then, new ones have been underwritten at higher CAP rates and interest rates.
But our self storage space and the economy as a whole have a lot of contradictions, such as:
-
- The economy is slowing down, but self-storage properties still earn record-high rents with few vacant units.
- CAP rates are rising, but there are still a lot of buyers looking for self storage (i.e., although less offers, there are still multiple offers for many offerings).
- Investors are also drawn to self-storage properties because they seem likely to weather the challenges that now seem likely in. For example, if inflation continues, self-storage properties can adapt by quickly raising rents as demand allows.
- The Fed wins the inflation war when they run the economy into recession.
- We are in an economic slowdown, or about to go into one, but employment is still high.
What does this mean for small investors trying to get into the self storage business?
I think (1), like in the height of the low-CAP-high-price era, look for deals that big money isn’t looking at. From the same WealthManagement.com article:
“Fully-stabilized properties in top metropolitan statistical areas continue to draw strong interest,” says Skyview’s Schoettlin.
We look for smaller mom-and-pop in secondary markets, conversion opportunities, etc.
We focus on what the well-funded, lower capital cost money isn’t looking at or looking at strongly.
(2) Underwrite with higher interest rates and use higher CAP rates in your future valuation portion of your underwriting. In most cases, we currently use 7% CAP rates for future years’ valuation.
Perhaps CAP rates will rise even more over the next quarter or so, which will start making existing facilities for sale even more appealing. But we will have to continue to look for deals larger funds or REITs are not looking at.
My bet is that interest rates will rise slightly more, then, towards the end of 2023 and or early 2024, they will start going down. Perhaps they will not get to the low levels we have grown accustomed to, but they don’t need to.
This is why we are not locking in interest rates at this point unless we have to. I would rather ride the next up wave, so we can ride the downturn that we think is coming.
Conclusion
So one valid strategy is to sit on the sideline and wait for something. Better economy, lower interest rates, etc.
I will never try to talk someone out of this strategy (the more that take this strategy, the better for us).
The other option is to see what is changing and how we can adjust and take advantage of it.
I have been waiting a long time for a cooling off in the self storage space, and we are perhaps seeing one of sorts.
This was one of the things I was grateful for this Thanksgiving.
