The Current State of the Self Storage Market: June 2023
Self Storage development is as hard as it gets right now.
After a period of low interest rates, reasonable construction costs, and surging self storage demand (driven by COVID), we now sit in a much different environment.
Here's the current landscape of the self storage market:
- Interest rates have gone from 0 → 5%, which means a construction loan went from 4% → 9%.
- The cost to build one of our storage facilities went from 75 → 95/sf.
- And rental rates went from $1.40 → $1.80 → $1.60 (still better than the peak of last cycle).
BANKING CRISIS
On top of this, regional banks, who are the predominant suppliers of construction financing in the commercial real estate sector, have almost effectively stopped lending to most developers.
Why?
3 reasons, mostly balance sheet-oriented issues:
- Deposit flight risk: After SVB, we exposed the nerve of what underpins capitalism: confidence. In a fractional banking system, if the dominos start to fall and people start pulling their deposits from banks, the House of Cards collapses. This started happening during and after the SVB collapse. Time (and hopefully larger guarantees by the FDIC in the future) will mend this, but it happens over years not months. In the meantime, banks will make fewer loans and require much more in terms of deposits from their lenders (developers like us) than they ever have in recent years.
- Many regional banks (who make up the bulk of CRE lending) have significant refinance risk with the assets on their balance sheet along with asset quality issues (office occupancies have not recovered etc). What does this mean? Even if a bank has a performing loan on its balance sheet, the advance rate on that loan was likely much higher than it would be today, which means either the lender puts more equity into the deal, or if they don't have it, the bank will have to sell the asset or work out the loan. The latter of those options forces the bank to put more risk capital against these loans which further constrains their balance sheet.
- The OCC: Banking regulators have been calling for higher capital standards at many banks across the country. And when do regulators generally enact more stringent capital regulations?! That's right, during a banking crisis. In the face of having to have more capital for each of its loans, a bank can either raise capital, reduce the size of its loan portfolio, or a combination of the two. None of these options is good for CRE.
WHY THIS IS GOOD FOR STORAGE
So, with all of the issues mentioned above, why do we still want to develop?
It has to do with what happens after these types of conditions hit the storage market last.
During the last major recession (2009) we saw a similar contraction in debt availability, which subsequently shut down the development of new storage facilities (below 2006 --> 2012).
What we know however is that storage demand is resilient, the most consistent out of any of the real estate asset classes.
So what happens when supply stops ❌ and demand continues to grow 📈?
Well, storage fundamentals benefit ⬆️
Below is a chart of the occupancy and revenue growth for Public Storage from 2010 to 2016, and as you can see occupancy went from 88% → 94% and revenue growth accelerated by 50% from below 4% to above 6%.
While each cycle has its own nuances, the same principles carry forward.
We are entering a period where supply is shrinking, but we know that demand continues to flourish.
If you can find a way to develop in spite of the headwinds, then you are creating value.
Finding a way to develop is what we are focused on daily, and why we are excited about the years to come.
