Allaway, Goldsmith, Sanabria

Self-storage REITs are facing a mixed picture today. While the strong tailwinds seen early in the pandemic have eased, some new customer habits formed during that period have persisted and should be supportive of future demand. At the same time, a sluggish housing market has presented a definite headwind that has impacted demand. Rent growth in the sector is expected to remain under pressure until housing-related mobility improves. spoke with Spenser Allaway, senior analyst at Green Street, Michael Goldsmith, analyst at UBS, and Juan Sanabria, managing director at BMO Capital Markets, about their views on performance trends, issues of scale, consolidation prospects, and more.

Do you see tailwinds triggered by the pandemic continuing to impact the self-storage sector today?

strong>Spenser Allaway: Work from home (WFH) and the decluttering of residences is a primary example of a pandemic tailwind that is here to stay. Decluttering is now fondly referred to as another demand stool for the storage industry. These consumers keep storage units longer than the typical consumer—particularly those customers who use storage temporarily when moving—and thus, absorb a great number of rent bumps. Thus, these WFH/decluttering consumers are additive to the storage demand pie and are a higher value customer.

Michael Goldsmith: The pandemic disrupted people’s way of life and created new habits that benefitted self-storage demand. Home purchases drove the need for temporary storage while moving. People were spending more time at home and needed to create more space.

As we sit here today, some of these drivers have pulled back, with the most notable one being housing turnover. Though, at the same time, customer length of stay remains elevated which suggests that many customers who started using storage during COVID remain customers today. Further, the sheer number of people that used self-storage over the last several years and experienced its value proposition should be supportive of future demand.

Juan Sanabria: I think there’s still some small residual WFH demand, but in general, COVID excesses have been flushed through the system at this point.

Looking ahead, what factors do you see having the most impact on self-storage performance?

Goldsmith: We see current demand as pressured due in part to lower home sales. This reflects a number of factors, including higher mortgage rates weighing on both buyers and sellers. For self-storage to bounce back, a rebound in home sales should drive demand, move occupancy higher, support move-in rates, and even benefit existing customer rate increases. At the same time, we think higher interest rates should limit new supply, creating less competition from lease-ups.

Sanabria: Limited for sale housing demand has hurt storage top of funnel demand since the fall of 2022 and has manifested itself in more aggressive pricing for new customers. Lower interest rates and their impact on housing related mobility will be key to stimulate incremental demand off of depressed levels.

There are also some anecdotes about increased multifamily supply spurring increased mobility as people are apt to move given lower rents and incentives being offered by apartment developers.

Allaway: Two key factors are likely to have an outsized impact on storage demand in the near term: 1) the broader macro environment, which has a direct influence on the financial health and sentiment of potential storage customers and 2) the strength of the housing market.

The healthier and more vibrant the economic outlook is, the better consumer sentiment will be. In the event that interest rates stay higher longer, consumers will feel greater pressure in terms of debt and mortgage rates, hampering their ability and willingness to spend on other things such as storage. In addition, because there is a strong correlation between home sale activity and move-in rent growth, the health of the 2024 housing market is crucial to storage demand. If the housing market remains sluggish, storage operators may see a repeat of the dismal 2023 peak leasing season.

In the medium- to longer-term, new supply will be the biggest headwind to storage fundamentals. There are various hurdles to new development right now, including unfavorable debt markets, labor shortages, permitting backlogs etc. However, development is quick to ramp up once the spigot is turned back on. Once new supply accelerates, existing storage facilities will need to compete more heavily to attract new customers, who will have a growing set of options to choose from.

Where do you see rents trending this year?

Sanabria: I think rents to new customers will continue to be pressured on a year-over-year basis through the first half of 2024, but for seasonal demand to be stronger. Storage prices to new customers should improve into the spring and summer with a steeper curve than last year, as housing-driven demand is unlikely to be worse than in 2023.

Allaway: New customer rents are expected to grow in the mid-single digit range year-on-year for 2024. However, if home sales do not accelerate as we move through the spring months, it seems more likely that rents could be flat or down slightly versus 2023.  Existing customer rent increases are expected to trend in the mid-teens year-on-year.

Goldsmith: We think move-in rents in 2024 will start the year down relative to last year and close the gap through the year. We think 2024 likely will see typical, but muted, seasonality as home sales remain under pressure. If home sales improve through the year, that would be supportive of rent growth.

What are the benefits of scale in this business, and is there additional scope for REITs to increase market share?

Goldsmith: As we see it, scale in self-storage is primarily about data and information. It allows operators to better understand market dynamics that inform many aspects of the business, including pricing decisions and acquisition opportunities. In addition, it helps leverage expenses through national contracts. While there has been consolidation of the self-storage industry, it still remains fragmented as 55% of institutional quality properties are not owned by REITs. This is an opportunity over time.

Sanabria: Larger datasets allow for smarter algorithms and efficient pricing models. REITs can run tests on different strategies with greater confidence if they have more data to work with

We expect the self-storage sector to continue to be consolidated over time and see REITs well-placed to take advantage of consolidation, particularly of unsophisticated owners/operators. REITs have seen a pick-up in third party management, which is likely tied to a harder operating environment, which likely is a precursor to increased acquisition opportunities.

Allaway: Scale is king in the self-storage business, as consumer data is as good as gold. The REITs utilize their large platforms to aggregate countless data points on all of their consumers. This data feeds the REITs’ revenue maximization algorithms, which signal to them when to raise rents, when to advertise more aggressively, when to offer concessions, etc.

The publicly traded self-storage REITs are estimated to own roughly 15% of the storage assets in the United States. Given that the industry remains highly fragmented and there is continually more supply being added via development, there is plenty of consolidation left to be had for the storage REITs.

REITs are also superior operators, which can achieve approximately 50-200 basis points of NOI upside out of assets that were previously run by smaller, less sophisticated operators. Thus, not only is there more opportunity to consolidate but there is ample operational upside to go along with it.

Are self-storage owners and operators  seeing clear benefits from offering modern, hi-spec construction that’s visually more appealing?

Allaway: While higher-tech, modern storage facilities offer slightly more amenities (e.g., touchless entry, kiosks, climate-controlled units, etc.), there is only a small rent premium associated with these centers. Interestingly, single-story, drive-up facilities will often garner higher rents because consumers like the ease of being able to drive up to their units and avoiding the use of elevators to move stuff in and out. Storage is a commodity-like good, and, as such, consumers care most about proximity to their residences and price.

Sanabria: It’s unclear. If consumers have a choice, they will likely pick the nicer building that’s well-lit and in which they feel safe, all else being equal. However, at the end of the day, storage is a needs-based product and largely a commodity asset type with customer selection based on location/proximity, and price.

Goldsmith: According to a UBS Evidence Lab survey, the most important factors when choosing a self-storage facility are price, location, and size of unit. Aesthetics is a lower consideration. That said, newer facilities do have features such as contactless entry, enhanced features, and potentially better security, all of which are factors that are relevant to the self-storage customer.

Which geographic markets have more room to absorb additional supply, and are you seeing any pockets of over-supply?

Sanabria: There does not appear to be a level at which penetration levels (square feet per person) impact storage fundamentals. So, I don’t necessarily think there are markets with too much or too little in-place storage. In general, supply is coming off of elevated levels and has generally been absorbed. We’ve typically seen new supply ramp the quickest in the Sunbelt market, given easier entitlement processes.

Over the longer term, we believe higher growth markets that are seeing population increases (e.g. Texas and Florida) will be able to absorb new supply easier. Two MSAs that come to mind that are still digesting elevated supply include Las Vegas and Phoenix.

Goldsmith: Self-storage truly is a micro-market business. As such, the ability to absorb supply really comes down to dynamics in smaller, three-mile-radius trade areas. While there are markets that are seeing broad supply growth, it comes down to the competition in the areas immediately adjacent to the new construction.

Allaway: Markets seeing outsized supply include: northern and central New Jersey, Philadelphia, Las Vegas, and Phoenix. Based on current estimated utilization per capita, markets such as, Boston, New York, Philadelphia, Washington, D.C., Phoenix, and Las Vegas are likely to have trouble absorbing additional new supply without a negative impact to existing facilities.

Moving forward, however, New York City will be the poster child for supply insulation as the removal of an important tax abatement for developers in 2020 means that new development will not be economically feasible in the future. As such, new supply is effectively zero for New York City and the boroughs in the medium and long term.

Are there other trends or developments you are watching, or find interesting, in the self-storage space today?

Allaway: For the next development cycle, more new builds are predicted to pop up across Sunbelt markets, which saw a tremendous amount of in-migration and rent growth throughout the heart of the pandemic. Sunbelt markets also have less barriers to new supply as compared to coastal and gateway markets, which will aid in the permitting process. Lastly, land values tend to be cheaper in these markets versus on the coast.

One of the most interesting trends we are seeing currently is the abandonment or pause of developments either underway or that have received permitting. The financing environment, with stricter lending requirements from banks, higher interest rates, etc., has put a real economic strain on development. In many cases, the hurdles are so high that the projects are no longer economically feasible.

Goldsmith: The stabilization in interest rates could lead to a reopening of the transaction market.