The State of the Real Estate Market

Commercial Real Estate

Development activity has slowed to a trickle. Only the best investment opportunities pencil in an environment where roughly two-thirds of the lenders are sidelined, interest rates have risen 40% in less than a year, and loan proceeds are ~20% less than we are accustomed to underwriting.

This dynamic has also created opportunities for well-capitalized groups. We are seeing more value-add and entitled development sites than ever before. Seller financing in the value-add self storage space is estimated to be offered in 50% of listed facilities by brokers at Marcus & Millichap.     

Self Storage

Self storage rental rates experienced a decline in 2023, largely due to decreased activity in home sales. Approximately 25% of storage demand comes from people moving homes. Most Americans have a mortgage rate below 5% and, in many cases, below 4%, making them hesitant to move into a 7-8% mortgage interest rate, even if they do want to move. It is DXD’s view this demand is pent up, and not lost. 

The length of stay has increased from 14 to 16 months for most storage customers. These additional two months will likely mean one additional rate hike. REIT consolidation has begun with Extra Space’s $12.7B purchase of Life Storage and Public Storage’s subsequent acquisition of Simply Self Storage for $ 2.2B. 

Extra Space has changed its rate strategy to incorporate lower “teaser” entry rates and then aggressively raise rates at three months (at DXD’s rented units by 35-52%). This has affected the way pricing looks on the surface. While the in-place rents and business fundamentals are strong, when looking at advertised web rates across the country, the decline looks artificially steep. This change has affected investor analysis, creating confusion about true market performance. It has affected the lending world in the same way. As we look to 2024 and beyond, there will be a re-education of how to analyze rates for self storage investments.  

Predictions

• Seller price expectations have fallen and will continue to fall over the next 12-24 months as many face increasing pressure on their capital.
• More seller financing offered in the value-add space.
  Banks will become flush with cash from depository requirements and will need to begin making loans again.
• As dry powder continues to grow and distressed opportunities are few, return expectations will correct, and Private Equity will be forced to continue to allocate funds.
• Reduced supply will help with absorption across many asset classes and keep cap rate expansion to a manageable level.
• Interest rates will begin to come down, which will stimulate home sales, moves, and self storage demand.
• Lenders will start analyzing self storage opportunities using “in-place” rents instead of advertised “street rates.”

Actions

Continue to pursue best-in-class investment opportunities, knowing our investments will face fewer new competitors during lease-up. Capitalize on stressed situations. Continue to improve efficiency through technology by reducing bottlenecks at every stage of investing.