Cap Rates Narrow in Storage Sector

BOSTON—Cap rates in the self-storage space continue to compress as spreads widen compared to 10-year Treasuries, according to a Self Storage Investor Survey released by CBRE's Valuation & Advisory Services. The survey comes a few days after Marcus & Millichap forecast increasing consumer demand for self-storage facilities, despite an accelerated pace of new construction.

Spreads rose at midyear to 395 basis points over the 10-year, an increase of nearly 14% over the end of 2015. This compares well with the 15-year average spread of 406 bps for the sector, according to Chris Sonne, EVP and national self storage valuation group leader at CBRE Valuation & Advisory Services.

Sonne notes that the current level is higher than the 2013 level of 320 bps, and is significantly higher than the spread low of 254 bps in 2006. He adds that this suggests cap rates will continue to compress and that self-storage may be less impacted by an increase in interest rates than other core real estate sectors.

Yield rates declined 12 bps to 8.63%, down from 8.75% six months earlier, according to the investor survey, which was conducted among 50 market participants. Of note is the fact that 75% of those interviewed rely on discounted cash flow as the primary tool of analysis, according to Sonne.

He says the anecdotal survey responses indicate that this is due to revenue enhancement or management models, or the ability to raise rents on existing tenants at any time. This has resulted in double-digit growth in revenue for self-storage REITs and some operators over the past several years.

More recently, self-storage revenues declined from double-digits a year ago to a range of 5% to 8%, but that's still more than double the CPI and outperforms other sectors. Revenue management success is likely to continue, but at a slower pace as occupancy and rent increases have grown significantly, according to CBRE.

Forecast rental growth rates have declined slightly since 2015 to a current level of 3.55%, according to CBRE. That's consistent with the pattern of slower revenue growth due to revenue enhancement models.

The growth is lower than increases seen in the past few years because respondents are using 10-year hold periods most often for discounted cash flow models that consider both boom and bust cycles, according to the survey. Expense growth factors increased nominally to 3.01% from 2.94% at the end of last year.

Marcus & Millichap's latest report on the sector finds self-storage “well positioned for the second half of the year as a resilient national economy, healthy population growth and rising disposable income support improving property fundamentals.” The strength of the labor market is driving improvements in retail spending and household formation; in turn, says Marcus & Millichap, “elevated consumption is outweighing available residential space, bolstering underlying self-storage demand.”

In addition, the report says, the strength of the multifamily sector is having a positive impact on self-storage “as apartments and other renter housing typically don't have the room to accommodate all of a resident's belongings.” Coupled with other strong fundamentals, the sector's vacancy reached a post-recession low at midyear.

These tight market conditions will leave the broader market poised for rent growth this year; however, some REITs may moderate hikes and deploy dis- counts amid rising competition,” the report states.

“The primary headwind facing the self-storage sector remains the threat of overconstruction,” according to Marcus & Millichap. Following years of post-recession undersupply, “development activity has taken off. Most of the building is localized to major metros that have the capacity to handle the influx; however, specific submarkets in these areas may face challenges moving forward.”

BOSTON—Cap rates in the self-storage space continue to compress as spreads widen compared to 10-year Treasuries, according to a Self Storage Investor Survey released by CBRE's Valuation & Advisory Services. The survey comes a few days after Marcus & Millichap forecast increasing consumer demand for self-storage facilities, despite an accelerated pace of new construction.

Spreads rose at midyear to 395 basis points over the 10-year, an increase of nearly 14% over the end of 2015. This compares well with the 15-year average spread of 406 bps for the sector, according to Chris Sonne, EVP and national self storage valuation group leader at CBRE Valuation & Advisory Services.

Sonne notes that the current level is higher than the 2013 level of 320 bps, and is significantly higher than the spread low of 254 bps in 2006. He adds that this suggests cap rates will continue to compress and that self-storage may be less impacted by an increase in interest rates than other core real estate sectors.

Yield rates declined 12 bps to 8.63%, down from 8.75% six months earlier, according to the investor survey, which was conducted among 50 market participants. Of note is the fact that 75% of those interviewed rely on discounted cash flow as the primary tool of analysis, according to Sonne.

He says the anecdotal survey responses indicate that this is due to revenue enhancement or management models, or the ability to raise rents on existing tenants at any time. This has resulted in double-digit growth in revenue for self-storage REITs and some operators over the past several years.

More recently, self-storage revenues declined from double-digits a year ago to a range of 5% to 8%, but that's still more than double the CPI and outperforms other sectors. Revenue management success is likely to continue, but at a slower pace as occupancy and rent increases have grown significantly, according to CBRE.

Forecast rental growth rates have declined slightly since 2015 to a current level of 3.55%, according to CBRE. That's consistent with the pattern of slower revenue growth due to revenue enhancement models.

The growth is lower than increases seen in the past few years because respondents are using 10-year hold periods most often for discounted cash flow models that consider both boom and bust cycles, according to the survey. Expense growth factors increased nominally to 3.01% from 2.94% at the end of last year.

Marcus & Millichap's latest report on the sector finds self-storage “well positioned for the second half of the year as a resilient national economy, healthy population growth and rising disposable income support improving property fundamentals.” The strength of the labor market is driving improvements in retail spending and household formation; in turn, says Marcus & Millichap, “elevated consumption is outweighing available residential space, bolstering underlying self-storage demand.”

In addition, the report says, the strength of the multifamily sector is having a positive impact on self-storage “as apartments and other renter housing typically don't have the room to accommodate all of a resident's belongings.” Coupled with other strong fundamentals, the sector's vacancy reached a post-recession low at midyear.

These tight market conditions will leave the broader market poised for rent growth this year; however, some REITs may moderate hikes and deploy dis- counts amid rising competition,” the report states.

“The primary headwind facing the self-storage sector remains the threat of overconstruction,” according to Marcus & Millichap. Following years of post-recession undersupply, “development activity has taken off. Most of the building is localized to major metros that have the capacity to handle the influx; however, specific submarkets in these areas may face challenges moving forward.”