When considering real estate investments, self-storage facilities might not be the first option that comes to mind. However, this sector has been steadily growing in popularity due to its high demand, ease of management, and being relatively recession proof. In this blog, we’ll dig into why self-storage is a unique investment option, key considerations when investing, financing options, and the pros and cons of this investment strategy.
Why Invest in Self-Storage?
High Demand and Strong Returns
Self-storage facilities are in high demand across the country. People need extra storage for various reasons—moving, downsizing, decluttering, or storing business inventory. This consistent demand translates into strong cash flow and high return on investment (ROI) for self-storage owners.
Ease of Management
Compared to other types of investment properties, self-storage facilities are relatively easy to manage. Many facilities are fully automated, reducing the need for on-site staff. Automation systems handle access control, payments, and security, minimizing daily management tasks. Additionally, since tenants usually rent units for a few months at a time, there are fewer concerns about long-term tenancy issues.
Recession-Resistant
Self-storage has proven to be resilient during economic downturns. Even in tough economic times, people still need storage solutions. In fact, demand for self-storage often increases during recessions as individuals downsize or move to more affordable housing. This stability makes self-storage a reliable investment option.
Key Considerations When Investing in Self-Storage
1. Choose the Market Carefully
The success of a self-storage investment heavily depends on the local market conditions. It’s essential to examine economic factors such as population growth, job stability, and the ratio of homeowners to renters. Proximity to residential areas, universities, and businesses is also crucial. Since self-storage is a micro-location-focused business, analyze these metrics within a 8 to 10 kilometer radius of the facility.
2. Examine Economic Occupancy and Cash Flow
Economic occupancy is a critical metric. Unlike physical occupancy, which only accounts for the percentage of occupied units, economic occupancy measures the potential income if the facility were fully occupied at market rates. Assessing this, along with local average rental prices, will give you a clearer picture of the potential cash flow from the investment.
3. Analyze Competition
Understanding the level of competition within your chosen market radius is vital. If there are many self-storage facilities in the area, attracting new tenants may be challenging. It’s also important to consider any facilities under construction or in the planning stages. Market saturation, measured by the gross square feet of storage space available per person, helps determine if the area is oversupplied or undersupplied.
Financing a Self-Storage Investment
Several financing options are available for self-storage investments, including conventional loans, small business loans, and private financing. Here’s a brief overview of each:
Conventional Loans
Conventional loans from banks or credit unions typically offer the lowest interest rates and the longest terms. These loans are ideal for investors seeking stability and predictability.
Small Business loans
As these types of assets are technically businesses getting a small business loan is yet another option you can explore when speaking with your financial institution. These loans are popular among first-time investors.
Private Financing
Private financing options, such as hard money loans, bridge loans, and mezzanine financing, can provide the necessary funds quickly but often come with higher interest rates and shorter terms. These are suitable for investors looking for short-term solutions or those who need to act quickly on an investment opportunity.
Pros and Cons of Investing in Self-Storage
Historically low interest rates and the asset’s positive fundamentals are starting to draw investors to self-storage with record speed. To be sure, self-storage is not a foolproof investment. There is risk, just as there is with any asset class. It is important for prospective investors to understand the pros and cons of the self-storage real estate industry before moving forward.
Here are some of the most pertinent pros and cons to consider:
Pro’s
- Pro: A low-maintenance asset.
Advances in technology (e.g., lighting and security systems) allow owners to operate self-storage facilities with relatively little supervision. Moreover, since each unit is essentially just a core and shell, very little maintenance is required. Most of these properties have small, if any, common areas to maintain and landscaping is sparse. Among all real estate property types, self-storage is one of the easiest and most affordable to maintain over time.
- Pro: A potentially stable, cash-flowing asset class.
Self-storage units have the potential to provide stable, consistent cash flow on a monthly basis. The short-term nature of the leases makes it easy for an owner to evict a tenant for nonpayment of rent, and then that unit can quickly be released, especially if a facility is operating with a wait list. As demand increases, owners can marginally increase rents-even by $2 to $5 per month-since most tenants are not locked into long-term, fixed rate leases. Moreover, administrative fees, late fees, and retail sales can boost cash flow further.
- Pro: Potential to diversify income streams.
While the base rent for individual units will always be the primary source of income for a self-storage operator, those with well-located facilities can utilize their building or property to diversify the products or services they offer. For example, self-storage operators with significant land may offer covered but unheated outdoor storage on excess land, spaces that can be used for goods that someone might otherwise store in a garage or shed. Operators might also partner with a company like U-Haul to make trucks or vans available for rent. Owners might also operate a fuel station, janitorial business, or other industrial service at their self-storage property as a means of diversifying their income streams and seeking to increase total cash flow.
- Pro: Historically recession resilient.
When the economy is good, people move, invest in home renovations, and buy more goods – each of which increases demand for self-storage. During recessionary periods, people downsize, move-in with roommates, and are sometimes evicted from their apartments. Each of these scenarios typically increases demand for self-storage as well. The multiple demand drivers for self-storage have historically made this an otherwise recession resilient asset class.
- Pro: Competitive financing.
Because many real estate owners also operate the self-storage business (i.e., an owner-operator), financing for the acquisition and any necessary improvements can be very attractive. Low loan-to-value, non-recourse loans are available through many banks. Small business loans are another attractive option for owner-operators. Many of these loans provide a substantial interest-only period to help lower costs while the owner stabilizes the facility.
Con’s
- Con: Short-term leases.
Self-storage leases generally operate on a month-to-month basis. This can result in high turnover and requires an operator to consistently market the property to ensure units quickly released upon turnover.
- Con: Potential Risk of oversupply.
Since self-storage facilities are relatively inexpensive to build and maintain, they get built quickly and easily during times of especially high demand. However, once demand tapers, there can be a resulting oversupply that puts downward pressure on rents at all facilities. It is important for any prospective investor to consider both existing and planned (i.e., permitted) competition within a certain radius of the facility they are looking to purchase.
- Con: Demand driven by hyper-local conditions.
A common mistake that self-storage investors make is purchasing a facility based on “planned” new housing construction. For example, a self-storage developer may go into an area with a sign that indicates an area is expecting “1,000 new housing units, coming soon!”. However, there’s no guarantee that those housing units ever materialize. Any change in the economy can halt new construction of those units and even if pre-permitted, those homes may never get built. Similarly, an operator may overemphasize demand from a local employer (e.g., a Mining Company) but if that employer shuts down, demand for self-storage could evaporate overnight. Prospective investors will want to be sure there is sufficient existing demand and that this demand is diversified to safeguard their investment.
- Con: Not entirely hands-off.
Many people wrongly assume that self-storage facilities can run themselves. While there is a lot that can be done to lower operational costs, these properties still need active management to ensure their success. Ongoing repairs and maintenance are necessary to keep the property in proper working order. Any investor will want to have a strong business plan in place prior to purchasing a self-storage facility.
Types of Self-Storage Investments
Self-storage investments generally involve purchasing a facility and renting out individual units. Facilities are classified into three types:
- Class A self-storage: these facilities are newly constructed (within 10-15 years), feature modern amenities such as climate control, are professionally managed, charge the highest rent, and have generally low vacancy rates. Class A self-storage is well-located and will often be coupled with other akin uses, such as a U-Haul rental or a UPS store.
- Class B self-storage: these properties are older (usually 15+ years old), are well maintained but may lack 24/7 on-site management, have limited amenities, and generally rent for average prices to low- and middle-income earners. These properties will usually be located close to main roads but not necessarily in prime locations.
- Class C self-storage: these facilities are older, in less desirable locations (often off-the-beaten-path), have few if any amenities, and limited security. These properties will often have the lowest rent and may require significant property improvements in order to generate a sufficient return for investors.
There is no “best” or “worst” class of self-storage. Each can be a worthwhile investment, depending on an investor’s risk tolerance and anticipated business plan.
Tax Implications
Investing in self-storage can offer tax benefits such as depreciation deductions and expense write-offs for repairs and maintenance. Interest payments on loans used to finance the purchase may also be deductible. Consulting with a tax professional is advisable to understand the specific implications for your situation.
Conclusion: Is self-storage right for you?
There are many reasons to consider investing in the self-storage industry, several of which we have identified above. Self-storage remains a highly fragmented asset class. Many facilities are still owned by mom-and-pop operators who are on the verge of retirement. This creates an opportunity for those looking to enter the market for the first time, especially for those who bring a more professional mindset to future operations and facility maintenance.
However, self-storage is far from risk-free. There are many nuances to this asset class that are often only learned through first-hand experience. Anyone considering investing in self-storage may want to ensure they take the time to educate themselves and learn all the intricacies of this investment strategy before diving in.
