Obviously it is not that simple. The key to a successful site depends, in large part, on supply/demand ratios. Too many sites that have been built or in the planning stages, are going to simply distribute the same number of renters among more units, an equation that leads only to occupancy and revenue declines. The best way to ruin, or at least slow down the momentum, is to begin to overbuild the marketplace. Long-term, excessive building only benefits the REITs as they will come into overbuilt markets and buy the distressed deals after the banks take them back (like many investors did in the early ’90s). Short-term, overbuilding hurts everyone. Interest rates are the second ingredient to the recent success formula. Sellers have been amenable to selling because cap rates are as aggressive as ever. The only reason cap rates are so low is interest rates are low. If a company borrows money at 7.75 percent and requires a 300 basis-point (3 percent) spread between the cost of debt (the interest rate) and the return on investment, then the target cap rate is going to be 10.75 percent. The companies require a spread between the return and the cost of funds because they have dividends to pay, operating expenses to absorb, etc.
If their interest rate goes to 8.5 percent, the cap rate goes to 11.5 percent because the company is still going to require a 300 basis-point spread. The cap rate is simply going to increase accordingly. What does this mean to the owner of a $2 million property? If a property generates $250,000 in NOI at a 10.75 percent cap rate, it would be worth $2,325,581. At an 11.5 percent cap rate, the value would be $2,173,913, a difference of more than $150,000 from just a 1 percent change in interest rates. Imagine what would happen if interest rates increase 3 percent or 4 percent. In my opinion, the activity level we have seen during the last three years is not going to continue, but I think the level of decline will be market-specific–more in some markets, very little in others. Why? Banks are loaning construction money on deals that shouldn’t be built, which results in overbuilding and unfavorable supply/demand ratios. What can we do, as an industry, to continue to build momentum and not stunt it? Cautious optimism. The industry is still very strong, and there are few indicators suggesting any substantial change ahead. There continues to be a tremendous amount of opportunity to capitalize on the success of the industry.
The secret: Be strategic. The resale market is very active right now, but it’s not going to stay that way forever. If selling a property is in your future, the self-storage REITs are, and will continue to be, the most logical buyers in most markets, because of their availability of capital and aggressive acquisition strategies. They can afford to pay more for most properties than an individual buyer or private company. One of the secrets to realizing the full value of a property is the manner in which it is marketed to the REITs. A real-estate broker is vital to an effective marketing campaign. Real-estate brokers are not getting paid to know who the buyers are.
They are getting paid to manage the sensitive process of marketing the property and implementing a very methodical, property-specific plan. What does this mean to the average self-storage owner? It all depends on your motivation. If you are going to be a seller anytime during the next five years, now is the time to at least test the waters. Sales prices haven’t been higher than they are today, so if nothing else, marketing your property is a free appraisal. Key indicators that your market is about to begin to “soften” include the following: •New self-storage properties are being built in areas that already have an adequate number of facilities.