About the Self Storage Confidence Index

Confidence in 2008? Among other areas, business headlines are highlighting concerns over the economy and a possible oncoming recession, wavering domestic stock markets, the weak U.S. dollar, high oil prices, the continuing credit crunch in financial markets, and slow commercial and residential real estate markets. These issues are clearly on the minds of American consumers, not to mention Democratic and Republican presidential candidates who are all suggesting remedies for our nation’s economic woes.

Amidst this turmoil, who has confidence in 2008? Self storage owners and operators do, because of the strong fundamentals of the asset class.

Scoring The Index

The scope of the First Quarter 2008 Confidence Index survey is based on eight questions regarding self storage facilities, such as forecast confidence in revenues, occupancy, and capital expenditures. The survey also analyzes industry sentiment regarding national economic conditions. Responses totaled 124, representing 30 U.S. states.

Storage Confidence Index scoring is based on a scale from 2 for each response that was answered “decrease significantly” to 10 for “increase substantially.” The responses are weighted by the percentage of responses for each question, and then multiplied by 10. A score over 50 generally indicates positive sentiment (60 is even better), and a score below 50 indicates a more negative outlook. However, in some categories, such as interest rates, a lower score suggests lower interest rates or a more positive outlook.

Sales Outlook

SSCI Question: What are your expectations for the 1st Quarter 2008 as compared to the 4th quarter of 2007 in the area of Industry Sales (rental income only)?

Sources: Self-Storage Confidence Index

Nearly half the respondents expect rental rates to increase slightly or substantially in the first quarter of 2008. However, 31.87 percent expect no change. This optimism supports the longstanding position that self storage is insulated from broader economic pressures, as it suggests that optimism among self storage players is higher than in other business and real estate sectors.

Looking further at these responses, rental income between the fourth and first quarters of any year is traditionally the self storage industry’s slowest period due to cold-weather seasonality factors throughout much of the country.

Given the Confidence Index’s timing, it is not unusual to see the varying responses on this question. While respondents from colder climates may naturally have a more pessimistic outlook at this point in any year due to seasonal sales slowdowns caused by the weather, Index respondents from warmer climates may base their answers on broader economic factors.

It will be interesting to see how these responses evolve in the next Confidence Index survey during a time when the storage industry traditionally experiences stronger lease-up velocity nationwide. That likely will offer a better feel for whether responses to this question are seasonally driven, or if broader economic factors are indeed pointing to a flat or declining sales market for self storage facilities this year.

Occupancy Levels

SSCI Question: What are your expectations for the 1st Quarter 2008 as compared to the 4th quarter of 2007 in the area of Industry Levels (physical occupancy)?

Sources: Self-Storage Confidence Index

Occupancy questions had the second highest weighted score (66.8) of all questions, with no respondents believing that occupancy would decrease significantly. Hence, for now, market players reflect a bullish outlook in the first quarter of 2008. This is especially unusual in winter months, as some self storage markets with extreme weather conditions can experience seasonal dips in occupancy.

Initially, occupancy was a big concern for the self storage asset because there are generally no long-term leases; typically they are month-to-month. This is important to investors because general real estate concerns often are associated with tenancy and cash flow. For self storage, this highlights the importance of trade area analysis upfront, with a focus on market conditions: supply, demand, and equilibrium.

In addition to seasonality factors, the bullish outlook of these respondents may also be attributed to owners who are focusing on boosting their facilities’ internal performance standards while the property transaction market awaits better capital market conditions.

What is interesting to note from these responses is that even with a slowing economy and continuing bad news from sub-prime, stock and residential markets, owner expectations for occupancy levels are positive. This is a good sign, especially when taking into account the winter seasonality factor.

Capital Expenditures

SSCI Question: What are your expectations for the 1st Quarter 2008 as compared to the 4th quarter of 2007 in the area of Industry Capital Expenditures?

Sources: Self-Storage Confidence Index

Capital Expenditures refer to operating expenses relating to the property normally associated with maintenance and repair. As outlined in the 2006 Expense Guidebook (a MiniCo publication), self storage does not often hold-back reserves for replacement of long-lived physical items. Instead, most spend as needed. Plus, self storage does not have high-end capital expenditures such as tenant improvements associated with office tenants or free rent associated with fixturization for retail property. Consequently, the largest response was “Remain Unchanged.”

Several factors could be affecting these responses: climate, year-end budgets, and reserves being used for capital expenditures. With the exception of commonly maintained property components such as driveways, roofs, and paint, large-scale capital expenditures for storage facilities are highly dependent on situational-based needs rather than on an ongoing basis.

Interest Rate Expectations

SSCI Question: What are your expectations for the 1st Quarter 2008 as compared to the 4th quarter of 2007 in the area of Interest Rate Expectations?

Sources: Self-Storage Confidence Index

The most typical response (41.76 percent) was a forecast that interest rates would decrease slightly. Yet, 35.16 percent expected no change and nearly 21 percent expected slight to substantial increases. Given the more negative sentiment regarding the national economy, it is unusual that most expect interest rates to stay the same (35.16 percent) or decrease slightly (41.76 percent). This may be a function of market confusion.

While the Federal Reserve continues to lower rates, the spread for risk continues to increase. Consequently, interest rates have increased over the past year while government policy and lenders are going in opposite directions. This may explain why there is uncertainty and seemingly contradictory responses regarding the economy and interest rates. On the other hand, some may believe interest rates will decline in response to concerns of recession over the policy of raising interest rates in response to concerns of inflation.

The varying answers to this question may demonstrate the uncertainty that some property owners currently have about interest rate levels. What they should keep in mind as we proceed through the first quarter of 2008 is that while current Treasury rates are relatively low from a historical perspective, market volatility has caused lenders to increase spreads over this base rate, which means a higher overall interest rate applied to storage financing. With more conservative underwriting standards being applied today to all commercial real estate property types, the days of lenders aggressively pursuing deals has slowed.

Cap Rates

SSCI Question: With the changes in the current interest rate environment, what effect do you believe this will have on cap rates in your markets?

Sources: Self-Storage Confidence Index

Linking interest rates to capitalization rates, responses were varied, but 35.17 percent expected cap rates to increase (slightly or substantially) while 34.07 percent expected no change. Only 19.78 percent thought cap rates would decrease, while 10.98 percent answered “Don’t Know.” Clearly, there is uncertainty regarding capitalization rates.

This question offers a fascinating market perspective because less than half of the responses expect cap rates to increase. The first quarter of 2007 is widely considered the pinnacle of the real estate and self storage industry with cap rates reaching all-time lows, due in large part to aggressive underwriting standards that allowed owners to obtain more highly leveraged financing. Capital market volatility had a profound effect on the lack of completed transactions in the last two quarters of 2007, and the first quarter of 2008 looks to have some continuation of that trend; although preliminary transaction volume in the first quarter has already seen improvements over the second half of 2007. Cap rates and the direction they move will largely be determined by the type of financing available and the depth of the buying market for a particular transaction.

National Economic Outlook

SSCI Question: What are your expectations for the 1st Quarter 2008 as compared to the 4th quarter of 2007 in the area of National Economic Outlook?

Sources: Self-Storage Confidence Index

Regarding macro economic conditions, respondents were asked about expectations for the national economic outlook for the first quarter of the new year. Nearly half or 45.05 percent expect a slight decline, yet only 3.30 percent expect a significant decline. Among all questions asked, this question created the most negative market sentiment.

Current media reports all indicate the American economy is, at best, at risk for recession in 2008. The data indicates a bullish market outlook and positive market sentiment for self storage, but concerns about national economic conditions.

As a group, self storage owners have always had a good ear to the ground and can tell when the market is experiencing a slowdown. With the mixed responses to this question, only time will tell how national economic factors affect our industry. The storage industry has long been thought of as a recession-proof industry, and while we are not in a true recession at this point in time, not having as much movement in the residential arena will test this theory.

Rental Rates

SSCI Question: For the 4th quarter of 2007 as compared to the 3rd quarter of 2007, indicate how rental rates at your facility have changed.

Sources: Self-Storage Confidence Index

Two questions focused on rental rates. The first was an estimate of rental rate increases in the next quarter, and the answers were contradictory to the second question regarding rental rates in the last quarter (fourth quarter 2007). For example, half the respondents expect rental rates to increase in the first quarter of 2008. Comparatively, 65 percent did not change rental rates in the last quarter of 2007. These data suggest a bullish optimism or may reflect the hope of a new year. Typically, responses would be more bearish in the fourth and first quarters due to weather and more positive in the second and third or spring and summer quarters.

In terms of rental rates, 50 percent of Index respondents expect an increase from the fourth quarter of 2007 to the first quarter of 2008. While this may be an indication of properties that are performing well, it may also be the result of operators increasing rents to compensate for lower occupancies. In addition, the fact that it is typical of storage owners to implement rental rate increases toward the end of the first quarter to gear up for the lease-up season should also be considered.

Sources: Self-Storage Confidence Index

SSCI Question: For the 4th quarter of 2007, what type of discount incentives did you offer to potential customers?

Concessions or discount incentives indicate a wide range of answers, but most (46.15 percent) offered no discounts to potential customers. This is probably a function of the survey sample, comprised mostly of stabilized properties. Concessions ranged from $1.00 move-in (9.89 percent response rate) to discounts exceeding 20 percent (13.19 percent response rate).

When considering concessions, it is important to note that concessions and discounts can be effective marketing tools, but they do not generate demand. Concessions can vary widely among stabilized properties, primarily a function of market conditions in the trade area. For example, over-supplied markets will generally have more concessions as facilities compete for market share.

Self storage property owners need to take into account which concessions work best. The answer depends on two key factors: A) Your market, and B) Your facility operations. For instance, if your facility is 85 percent to 90 percent leased, it may not make sense to offer any concessions at all. Instead, you may consider boosting your revenue by increasing rents on existing tenants. If you don’t fall within this occupancy range and your local competitors are offering concessions to lure new business, it may be wise to consider concessions as part of your property’s marketing strategy.