With much talk of a looming recession, many investors are looking for somewhere to park their money that will protect them from the volatility of the stock market. With demand drivers that are more negatively than positively correlated with a recession, as well as relative immunity to downturns in the broader market, self-storage (SS) facilities can provide just that. Let’s take a look at why every investor should round out their portfolio with this alternative asset class.
1. Asset class returns & recession resiliency
When considering any investment vehicle, an investor should always be concerned with, among other things, (1) projected return and (2) downside protection. According to the National Association of REIT (NAREIT), SS produced an average annual return of 17.43% from 1994-2017. That’s a staggering 4% higher than the next best commercial real estate (CRE) asset class, manufactured home communities (MHCs), at 13.27%. The same source listed the following average returns during 2007-2009 recession:
- SS: -3.80%
- Apartments: -6.72%
- Office: -8.16%
- S&P 500: -22.03%
While self-storage returns are negative, the class offers a smaller loss than other CRE asset classes and is roughly 7x better return than the stock market during one of the worst recessions of our lifetime. This is the epitome of downside protection and capital preservation. You may ask, “why is self-storage so recession resistant?” Well, it’s simple consumerism; when the economy is on the rise, people buy more stuff and need a place to store it. Alternatively, when the economy is in a downturn, consumers tend to downsize their dwelling and need a place to store their stuff as they don’t want to get rid of it.
2. Rent growth and positive NOI
Green Street Advisors recently projected SS as the #3 CRE asset class for future outlook. One convincing reason for this outlook is that SS facilities employ a month-to-month lease strategy, which allows monthly rent increases. This affords SS operators the opportunity to be much more flexible and agile with their business plans, as they are not constrained by long term tenant leases. When considering SS, it is easy to see that tenants are much less price sensitive than they are in other asset classes. For example: take a unit being leased at $100/month, a 6% rent increase, or $6/month, is not likely to prompt a tenant to take a weekend and spend several hundred dollars to move to a different facility that is fractionally cheaper.
Net Operating Income (NOI) is the name of the game in CRE. Small increases in NOI can have dramatic effects on the valuation of a property. This is good news for the SS sector, as it has outperformed nearly all other CRE asset classes in same store NOI growth since 2000 and has experienced almost zero quarters with NOI growth in that same period.
Let’s take a look at an example of the power of NOI. First, know that NOI/CAP = FMV (fair market value). For the purpose of this example, assume a CAP rate of 5%. With these two things in mind, one can deduce that a small increase of $1/month or $12/year of income would lead to a FMV increase of $240 (12/.05=240). Now scale that $1/month increase to a $1/month rent increase across the board at a facility with 1,000 units. 12,000/.05 = a FMV increase of $240,000. At a $10/month rental increase per unit, a FMV increase of $2,400,000! You can see where I’m going with this.
3. Easy to maintain and low overhead
Many SS facilities are built primarily with sheet metal, which is significantly easier and cheaper to maintain than brick, siding, stucco or any number of other materials that traditionally comprise physical structures. They also consist of far less plumbing and electrical, which can both lead to exorbitant CapEx expenses, effectively reducing NOI and in turn the property value.
For multi-family and other CRE properties, turnover can be a rather significant line item. From cleaning or replacing flooring all the way to painting, this is a time consuming and cost inefficient reality of some asset classes. SS, on the other hand, doesn’t suffer from this pain point. For the most partly, simply clearing any left-over junk and sweeping the unit out has it ready for the next tenant at nearly no cost and no time lost. Less onsite staff is yet another great way that SS remains cheaper and more operationally efficient than comparable asset classes.
4. Average tenancy of 2.5+ years
For the 9.5% of U.S. household that rent a SS unit, the average tenant stays more than 2.5 years. As consumers downsize or buy more things, what was previously a want overtime becomes a need. This longer tenancy results in two conclusions: (1) there will be fewer turnover costs associated with this asset class, and (2) it supports the viewpoint that tenants are price insensitive, and are willing to take on gradual price increases (totaling less than a few hundred dollars per year) for the convenience or storing their things and not having to move locations.
5. Cash flow and tax benefits
Cash flow and tax benefits complement each other very well with this asset class. Annual cash flow in the 6-10% range is common to see in the SS sector, while many offerings are structured with a preferred return (passive investors first right to money) of 7%+, and significantly greater annualized returns when taking into account equity events such as a refinance or sale. Meanwhile, passive investors in syndicated deals benefit from pass through taxation. Cost segregation studies and K-1 tax forms allow the Operator to pass along common tax deductions such as property taxes, debt interest, accelerated depreciation and more to their passive investors. What this ultimately leads to is earned income while showing a net loss on your taxes and even offsetting other passive gains in your portfolio!
In sum, it is no surprise why the investment community has largely turned their attention to self-storage as a viable commercial real estate asset class. With strong historical performance, demand drivers that can’t be bothered by a downturn, and characteristics that support growth into the future, self-storage provides a rock solid opportunity for investors to earn stable cash flow and preserve their capital if bought at the right price with the right operator.