The Recession-Proof Sector

By Alice Chung, Analyst, CRE Finance, Moody’s Investors Service

Because the self-storage sector responds flexibly to consumer demand, self-storage real estate investment trusts (REITs) do well in both good and bad economic times. When compared with traditional property types, this asset class has the highest total annual returns over five- and 10- year averages; the sector posted a total return of 31.4% in 2014 and of 20.9% the prior year, according to the National Association of Real Estate Investment Trusts (NAREIT). The sector’s strength is tied to its ability to weather busts in the economic cycle, as its relatively quick recovery from the economic recession demonstrates.

Several unique characteristics of the self-storage business are responsible for its resilience in the face of adverse market conditions: short-term leases that give business owners the flexibility to respond to market changes quickly; a diverse customer base, which reduces the risk of single-tenant exposure; and strong business performance despite changes in the economy or in a customer’s life style, such as those related to divorce or a downsize in housing.

The largest self-storage companies continue to be publicly traded companies, the top three of which are all REITs. The sector is highly fragmented and competitive, but the publicly traded REITs have a distinct advantage over smaller competitors because their access to capital at rates substantially lower than rates for private operators allows them to acquire smaller operators. Also, superior revenue management systems and in-house call centers allow them to capture more sales volume.

Even so, the self-storage industry is still dominated by mom-and-pop operators, and while opportunities for consolidation will continue to exist, it is unlikely that consolidation will lead to self-storage REITs claiming market share over small operators. The self-storage industry has minimal capital expenditures and a low break-even occupancy rate, at approximately 60 percent to 72 percent—factors that help boost profitability no matter what the size of the operator.

Rising interest rates are the biggest challenge for self-storage REITs today. When the cost of capital goes up, it becomes more difficult for them to expand their businesses. However, we believe this risk is partially mitigated by REITs’ ability to pass any increase in costs onto its customers almost immediately via their month-to-month leasing agreements, a credit positive.