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Partners in Profit

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Partners in Profit

Mom and Pop were on to something.

Like no other time in the self storage industry’s almost 50-year history, private equity and institutional investors are flocking to the sector as it continues to post the highest long-term returns of any commercial property type. With the industry still largely in the hands of small business owners — including those small, family-run storage facilities — investment groups see plenty of room to consolidate, expand their platforms and gain the scale needed to extract greater earnings from operations.

“It’s amazing the amount of attention self storage has gotten over last few years relative to the past,” said Ryan Burke, an analyst with Green Street Advisors who covers the storage industry. “Traditional private equity and other types of institutional investors are at least looking at the space. Certainly there is more capital chasing self storage properties than there are properties to go around. The strength of demand is incredible.”

Private equity taking an interest in self storage isn’t new. Heitman Real Estate has provided equity to self storage for decades. Groups like Harrison Street Real Estate Capital have been involved for nearly a decade. But strong returns have increased investor interest.

Among the biggest examples:

  • Sovran Self Storage Inc. announced in May that it has agreed to buy privately owned self storage operator LifeStorage LP for about $1.3 billion. The deal was a success for TPG Capital LP, a private equity firm, which had invested $120 million in LifeStorage just two years earlier.

  • Toronto-based Brookfield Asset Management in January announced it was acquiring an $830 million stake in Orlando-based Simply Self Storage, the eighth largest self storage operator in the US. With the assets, Simply is on an aggressive plan to grow.

  • The William Warren Group, one of the country’s largest private self storage operators, teamed up with The Carlyle Group to develop self storage facilities.

Why They Want It

The self storage sector has been leading returns of all real estate for the last five years, 10 years and 15 years, said Marc Boorstein, a partner with MJ Partners in Chicago. According to the National Association of Real Estate Investment Trusts, average total return, including dividends of the self storage REITS in 2015 was 44.9 percent. For the past five years the number has been 32.7 percent.

“Storage came out of the recession holding up so well, so investors see that if we ever go into another recession we like the upside and the downside. That’s a rare product type,” Boorstein said.

Earlier this year, Merrill Lynch made the case that self storage REITS stocks remain attractive based on expectations for further market share gains. Occupancies are averaging 92 percent with solid demand.

Harrison Street Real Estate Capital has invested in self storage — along with student housing, medical office buildings, cancer centers and senior housing — over its decade in business and remains bullish on the sector.

“If I told you we knew it would be this hot, I’d be lying to you,” said Elliot Pessis, senior vice president of Harrison Street. “Everyone got lucky. It speaks to those fundamentals.”

Charles Byerly, president of Westport Properties and US Storage Centers, says it’s important to note that the current global monetary environment has created an abundance of capital seeking any return it can find.

“With that said, self storage has certainly shown the investment community it is worthy of being mentioned in the same breath as any other product type,” he said. “I think investors are noticing the industry’s resiliency in downturns and the low capex requirement.”

How the Deals Look

Over the past few years, the four major REITs — Public Storage, Extra Space Storage, CubeSmart and Sovran Self Storage — have locked up most of the biggest deals. But portfolios sold under about $70 million have attracted many aggressive private buyers, said Boorstein. Cap rates have plunged, because of so much competition and partnering.

Boorstein says the REITs have $2.5 billion in new deals closed or under contract by June of this year, setting a pace that will certainly surpass the $3 billion in deals done last year.

“We had a portfolio in Indiana that got 16 offers,” Boorstein said.

Andrew Guinn, acquisitions director of Austin, Texas-based Virtus Real Estate Capital, says his company is focusing on properties valued at $3 million and over, but he knows groups buying properties for $1.5 to $2 million and making the deal work.

“The market conditions are very frothy with lots of groups competing for deals,” Guinn said. “We’ve targeted certain markets and prefer to approach owners directly. We’re not competing for heavily marketed deals.”

The Challenge

And therein lies one of the biggest challenges for investors wanting to make a play for self storage.

“Private equity buyers realize it’s difficult to get a meaningful presence in the industry by buying a deal here or a deal there,” Guinn said. “The total deal size is too small to build up $100 million in product in a short amount of time, so some large private equity groups are purchasing operating companies instead.”

The fragmented nature of storage is attractive to investors because there’s room for consolidation; but it presents a challenge to building the scale believed to be needed to drive strong returns.

“Private equity isn’t going to invest in the space if they can’t buy or build a big enough portfolio,” Burke said. “More private equity groups have tried and failed than have been successful. Private equity has to weigh their resources, potential returns and make the decision.”

As REITS hold larger market share in the top 25 largest markets, Boorstein said he sees private equity groups looking for opportunity in secondary markets and some tertiary markets.

When new buyers come into a market, it doesn’t mean that private equity is always the best source of cash to proceed with a new deal, said Byerly of Westport Properties.

“Private equity is expensive, comes with less control and more reporting requirements,” Byerly said. “However, with that said, PE will take more risk, fund larger endeavors and add value with their internal resources that may not be available from other investor types.”

Byerly believes the market is becoming more and more difficult for private equity to reap the rewards seen this year. “A small handful of private equity firms timed their entrance into the space well and their exit will be very profitable. I don’t believe this can be duplicated with an entrance today.”

Few in the industry believe storage returns can continue to grow at their current pace, but market fundamentals are likely to hold strong until more construction gets underway. Only about 400 to 600 new properties are expected this year, compared with 3,000 during the last boom. 

“New development is the biggest wild card,” Burke said. “It’s tough to measure, and there’s a lack of data. It’s going to start affecting certain markets but the national level impact is further out on the horizon.”

Changes to Come

As strong industry returns and abundant private investment interest boost self storage’s credibility among lender and other buyers, the trend has the potential to impact the sector long term.

Along with increasing consolidation to more sophisticated management platforms, most watchers say the current investment flurry is likely to accelerate the level of third party management within the industry. Many private equity partners won’t joint venture with owners unless a third party manager or REIT is brought in to market and manage the property.

“I think this time will lead to a more institutionalized nature to a good share of storage properties,” said Pessis. “I think there will always be an element of Mom and Pop to self storage, but it’s like multi-family was 20 years ago. Storage is a major food group now. And where there’s yield, investors are going to come.”

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