Why Self Storage Has a Lock With Investors

Featured in Multi-Housing News

By Tom Dao

Despite current challenges, quality operators have maintained their access to capital, according to Gantry's Tom Dao.

Even with the sustained headwinds of a challenging market, the self storage asset class has remained relatively healthy and an attractive investment target.

Investors appreciate the steady returns resulting from increasing demand for self storage units in growing markets, and a maturing industry that has brought discipline to property management and the acceptability of self storage as a high-performing asset class. Self storage as an asset class has definitely captured the attention of large institutional investors because of its stable cash flow from the “stickiness” of its occupancy and rental rates once the property is stabilized. Aside from some seasonal trends, a well-managed store should not experience steep drop-off in revenue from month to month. Lenders, in turn, continue to have faith in quality assets and quality operators in equal measure.

This was a consistent refrain at last week’s California Self Storage Association Owners Summit in Newport Beach, a conference focused on national issues as much as local trends. The consensus? Self storage has its concerns to address but will continue to showcase encouraging performance and remain a popular investment target into the second half of the year.

The Headwinds

We were seeing some consistent improvement to treasury yields at the start of the year before the return of upward pressures and volatility post “liberation day” from the uncertainty created by a new tariff policy and global economic shifts that have yet to be fully defined. Not all volatility has come with pain. Some of the recent rate movement briefly included a nearly 20 basis point yield drop for the 10-year before returning to this year’s consistent benchmark of at or near 4.4 percent. We need to expect that we will remain in a volatile rate climate for the foreseeable future. A challenge indeed as we work through a wave of maturities from a lower rate cycle.

Like all asset classes, self storage is affected by this rate climate. Pricing assets for sale, refinancing maturing debt from better rate days or repositioning a property for improved metrics all come with a higher cost of capital. A higher cost of capital has become the new normal for planning. Accounting for this new cost model has led to an increase in active transactions, but volatility will continue to frustrate efforts to plan from a stable, consistent expectations.

Even so, for conservatively leveraged assets, we are still seeing strong permanent refinance options that are either cash neutral or cash out. Construction debt is available for well-underwritten projects in healthy submarkets. Bridge and debt fund options exist from multiple sources for projects in transition. There are viable solutions for almost every form of project. Despite the headwinds, the capital market is liquid and ready for a good deal.

Performance a Tale of Two Markets

Supply constrained markets like California continue to demonstrate strong operating fundamentals for self storage demand, even in the face of weakened market drivers. This is driving interest in acquisitions. While the slowdown in the single-family home market has weakened demand nationally, California’s dense urban markets and strong demographics foster a consistent demand for self storage space. In major coastal markets like the Bay Area, Los Angeles, Orange County and San Diego, the high barriers to entry for competitive new development will continue to support performance at existing facilities. This holds true for similar major markets in the Northeast, Midwest and Pacific Northwest.

In growth markets across the Sun Belt and in Texas, where new development has few barriers to entry, overbuilding is a risk and meeting rent and occupancy expectations can be a challenge. But, compared to 2023 and 2024, the industry is seeing improving occupancy and rental rates. Stronger markets are showing less sensitivity to rate increases while other markets are more value oriented, and operators must adjust prices more frequently to retain occupancy. Where markets are oversupplied, and these macroeconomic headwinds are slowing down lease up and rent growth, we have seen softening but not to the degree that a financing solution doesn’t exist in-line with most asset metrics and performance.

Lender Universe

For the time being, self storage continues to enjoy broad access to ready debt capital for all levels of asset type and performance. For construction financing, borrowers should anticipate rates at 2.5 percent to 3.5 percent over SOFR. Permanent refinancing costs are coming in at 150 to 200 bps over a corresponding bond yield. After the end of the inverted yield curve, many borrowers are choosing five-year loans over 10-year loans. Prepayment flexibility is highly sought after to preserve flexibility in case interest rates improve from their current condition.

However, borrowers must keep in mind that prepayment flexibility comes with a premium that must be paid either up front in the form of a higher rate or at a later stage in the form of an exit fee. Insurance companies, CMBS and, increasingly, banks are all actively competing for allocations to the sector as they prioritize self storage as a preferred asset type to lend to relative to other traditional asset types, such as office and hospitality, that are experiencing difficulties in this market.

The capital markets are strong, and there are almost always competitive options for assets across the spectrum of the investment cycle: stabilized, stabilizing, value add. For the best performing assets, permanent debt from insurance companies, banks and CMBS lenders is readily available, and can often include interest only. Bridge lenders can step in where operating metrics are still unable to support a permanent solution, and hybrid core plus loans that take into account pre-stabilization performance are available when they make sense, mainly for new construction in lease up.

Legislative Priorities

As the self storage sector has evolved to a more institutionalized operating model, interest from government and regulators has increased in tandem. A big topic at the CSSA event was how to align local chapters as a group with the national association on key issues to the industry. There is an overriding theme to some regulatory threats against self storage that have emerged. Essentially, legislators are looking to place a form of rent control on self storage property. Industry leaders in California were successful in curbing the passage of SB 709, a state bill proposed to curtail aggressive rent increase practices in self storage. The original proposal was to cap rent increases. It has since been modified to a rent increase disclosure requirement. The final bill is still pending Assembly approval.

Larger footprint operators discussed this Existing Customer Rent Increases conundrum and how the industry should and can self regulate before regulators come in and act. Larger REITs think it’s appropriate because of monthly leases to raise rates to what the market will bear as long as these intro teaser rates are properly disclosed and the customer knowing they should expect increases. Other operators expressed having to be reasonable in the increases. Preserving in-place rents versus chasing potential rent that can lead to vacancy should be the goal of operators in a self-regulating model that avoids government intervention. The industry does not need to invite more regulation.