Happy New Year!
Today I’m going to write about something I have great conviction about: my predictions for the self-storage market in 2023.
Here goes:
- Rental rates and occupancy will decline across the board in most markets.
- Distress in the self-storage market will be mostly limited to REPE buyers.
- Off market acquisitions will be less effective than on market. Q1 will be slow, Q2 – Q4 there will be action.
(I realized this email is getting too long – so I’m going to dive in to #1 and #2 thoroughly today and hit #3 sometime next week)
Rental rates and occupancy will decline across the board in most markets
“Will more homes sell in 2023 than 2021?” I think most people would say absolutely not – interest rates are pushing the cost of home ownership too high; people will struggle to afford homes at a 7% interest rate and therefore less homes will be purchased.
Because less homes transact, less people will move. Movement is a huge driver of demand for self-storage, and thus, as we are already seeing, rental rates and occupancy will decline across the board in 2023.
How much?
No idea, but I would say that we are probably not going to hit peak 2021/2022 rental rates until houses start to transact again. If you invested in a sponsor who underwrite to or even near peak rents, that could be an issue.
So, what will happen to the owners and LP’s?
It depends who we’re talking about.
Most self-storage operators are not very levered. REITs, who own 33% of the entire market, are using ~30% leverage on average.
Mom ‘n’ pop operators, who own at least 30% of the market, are, in my personal experience, barely levered. Most own their properties outright or have a very low loan to cost.
On the flip side, those who will certainly face distress are those Real Estate Private Equity groups that were particular active “deploying” capital last year. These operators not only primarily used floating rate debt (as is the nature of large credit facilities), but they also were betting on rental rates to run at +5-10% YoY.
These funds paid prices that could only be justified by 5-10% annual rent growth with sub 4% debt, and they modeled exit caps reflective of the environment of 2021. Today, their interest expense is 2-3x higher than when they closed, market rents are dropping, and the market to sell at a sub-6% stabilized cap rate is pretty much gone.
Let’s forget for now the fact that many of these REPE groups may not be able to make payments on this debt… If we solely focus on valuation, and we assume that the valuations in private real estate will eventually reflect the public market’s recent disenchantment, then it’s quite possible that nearly all of the equity in many of these private deals has been wiped out.
I’m not going to claim to know by what degree NSA’s stock price will reflect Storage Rentals of America’s (private fund) portfolio valuation, but these groups were competing with each other to buy the same deals, REITs are typically the end buyer for their large portfolios, and based on the bid-ask spread I’m seeing I wouldn’t be surprised if at least 50% of the equity in these deals would be wiped out were they to sell or refinance today.
Now, if these funds are not able to make payments on their debt, that could be a serious issue. I believe that we will see distress and some forced sales at the large REPE level.
To what degree will we be able to capitalize on this? That depends on two things: what other vultures show up, and how fast we can move.
First off, institutional assets typically don’t have any meat on the bone, but we will be able to out manage the institutions, at least from a cost perspective. Large REPE groups and REITs manage with full time employees, we do it with remote employees and a call center. I estimate we can cut total management fees, which includes our PM fee and salaries, by around 35-40%. In the past this hasn’t made us competitive because of how insanely the assets have been priced, but I believe that will change and we’ll have an edge against the more AUM focused vultures.
Second, we’ve established many relationships with large equity partners, but how many will show up when there’s blood in the water is yet to be seen. If you are interested in a partnership to acquire institutional grade assets, have $3m+ to deploy, and we haven’t spoken – please reach out, let’s get connected.
Ultimately, my strongest conviction is that we will buy considerably more storage in 2023 than 2022, and we’ll be very happy that we waited to pounce.
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