What’s Causing Distress in Self Storage?

Mike Mele, Vice Chairman, Self Storage Advisory Group, Cushman & Wakefield. Image courtesy of Cushman & Wakefield

Although the self storage industry is deemed more resilient during uncertain times than other real estate sectors, the widespread economic fallout is causing distress in the storage business as well. The sector started feeling the impacts of the novel coronavirus in April, as rental rates took a downturn in most markets across the U.S. The chaos caused by the crisis is both fueling and diminishing demand for storage spaces: While people who need to downsize are driving the need for storage units, growing unemployment might cause a decrease in demand, according to Vice Chairman Mike Mele, the leader of Cushman & Wakefield’s national self storage advisory group.

In the interview below, Mele discusses some of the positive and negative effects the global health crisis is having on the self storage sector. He also touches on investor sentiment and future opportunities the industry might offer.

READ ALSO: Self Storage Rents Not Immune to COVID-19

How would you characterize the self storage industry before the coronavirus outbreak?

Mele: Before COVID-19, the self storage industry was thriving. Self storage construction spending in the past five years has been at an all-time high, with peak deliveries in 2018. As a result, some markets were becoming oversupplied. However, the demand for storage was strong, interest rates were low and stores were leasing up.

Which aspects of the storage sector have been most impacted by the pandemic? 

Mele: Lease-up, certificate of occupancy and new development projects are being impacted the most by the current health crisis. This is the result of declining or flattening rental rates that will continue to be in effect for the remainder of the year.

Self storage has done very well to adjust to the current health crisis. Many REITs and high-performing operators have implemented touchless entry to conform with new social distancing standards. Additionally, on the performance side, as job loss and unemployment rates rise, we may see a spike in new rentals from people who are forced to downsize. On the other hand, unemployment may also lead to a decrease in demand, which could be the sole source of distress in the industry.

How do these impacts vary across markets?

Mele: The impact of the coronavirus on the self storage industry varies from market to market. Facilities located in areas with higher infection rates that will be slower to open will be affected the most. Although it’s too early to tell where rental rates will fall in the next year or two, in the short term we can assume markets with high infection rates will see longer periods of a rate freeze on existing tenants, and decreases in asking rates for new tenants the longer they are in lockdown. However, lockdowns in major cities could lead to occupancy improvements in suburban and secondary markets, as more people flee to these areas to quarantine.

READ ALSO: A Conversation on Self Storage Amid the COVID-19 Crisis

What makes self storage less vulnerable to economic disruptions? 

Mele: Self storage is considered by many to be an essential business, allowing for continued operations in a time of crisis. Demand for storage has countercyclical properties and often comes from positive and negative life events. The chaos caused by the coronavirus will likely create many new customers and keep current renters. Some examples of new tenants during the pandemic will be businesses that are downsizing their office space and children who are moving back home to live with parents temporarily. If the work-from-home trend continues, people may also need to adopt outside storage to make space in their homes.

Additionally, because self storage facilities have many tenants, there is less financial contribution to the per-tenant bottom line. This safety net provides diversification that protects storage investors from dramatic drops in rental income. So far, the demand for storage has stayed relatively strong and is projected to remain so—due to its stable property fundamentals—even if the economy is slow to recover.

Has investor sentiment changed during the pandemic?

Mele: Today, we’re seeing far more optimism than we did two months ago in the self storage industry. Deals are beginning to pick back up and people are more curious than ever about where the market lies. Investor underwriting is changing, as they are cautious about the future and are accounting for little to no rent growth. Rising interest rates are resulting in cap rates rising by 50 basis points on stabilized facilities. Lease-up facility underwriting is conservative due to the uncertain future. However, there is an enormous amount of capital on the sidelines waiting for distressed and opportunistic deals.

What advice would you give to investors during these challenging times?

Mele: The advice I would give to investors during these challenging times is to be communicative, collaborative and patient. There will be many opportunities as the market emerges. With all the new construction that has been introduced into the market recently, we expect that once the market stabilizes from the pandemic, we will see an uptick in sales.

How do you expect construction and acquisition financing to change going forward?

Mele: Billions of dollars in construction loans have already been affected by the coronavirus outbreak. We can expect construction spending to dry up and CMBS financing for acquisitions to be extremely difficult to achieve for the remainder of 2020. In the short term, we will see financing through life companies and local banks at higher rates and lower LTVs with more concentration on the sponsor. In the long term, we expect CMBS to open back up due to the stability of the sector in 2021. We also expect rates to return to pre-pandemic levels around the same time, assuming we get through the virus with vaccine and treatment, and get to the light at the end of the tunnel.