Last quarter’s survey, the first conducted, found that strong self storage industry fundamentals led to confidence amongst industry professionals, despite national economic uncertainties. This trend has continued, with the national economy moving closer to recession and confidence amongst self storage industry professionals growing.

Confidence about capitalization rates remains high, with responses virtually unchanged over last quarter. In contrast, second quarter SSCI respondents’ confidence in the nation’s economic outlook is low and has decreased since last quarter. According to Chris Sonne of Cushman and Wakefield’s Self Storage Industry Group, the contrast between self storage confidence and the national economy, “suggest market sentiment for self storage is better than the economic outlook. This may be because self storage has tended to hold up in bull and bear economic cycles better than other real estate asset classes. As an example, vacancy trends are less elastic.”  

Rental Income And Concessions

Fifteen percent of responding self storage professionals expect rental income to increase substantially over first quarter 2008, while just over half expect rental income to increase slightly, and a quarter expect rental income to remain unchanged. Only nine percent expect a slight decrease in rental income in the second quarter, and none expect significant rental income decreases. The expectation of second quarter income increases could reflect plans to raise rates in anticipation of increased demand during warmer weather. Some of those rate increases, however, will have taken place in the first quarter, so such strong sentiment about income growth is surprising.

Comparing first quarter 2008 with the same quarter 2007, 50 percent of respondents indicate that rental rates have increased, and over a third of the respondents indicate that rates have remained the same. Only 10 percent report year-to-year rate decreases.

Industry professionals are substantially more confident about rental rates today than they were three months ago. In the first quarter of this year, just under half of SSCI respondents expected to see rental incomes increase during that quarter compared with 66.4 percent this quarter. The proportion of respondents expecting rental incomes to decrease has dropped by over 25 percent. It should be noted, however, that upward trend lines in rental income forecasts between first and second quarters are typical due to seasonal occupancy changes. Such strong confidence in the face of recessionary pressures in the larger economy reinforces the belief that self storage is insulated from economic downturns.

Self storage owners and operators report mixed, but mostly negative trend results regarding discount incentive offers. Fifty-six percent of the respondents report having offered some discount this quarter, which is up from 54 percent last quarter. Twelve percent offered a dollar move-in discount, up from 10 percent. While the percentage of owners and operators offering discounts of under five percent dropped, the percentage offering higher discounts grew. This could be a function of local market differences. As the economy slows, facilities in strong markets are affected little, while facilities in weak or oversupplied markets feel the need to increase their competition for the small pool of new customers.

Occupancy Levels

Industry professionals are bullish on physical and economic occupancy rates. Fifteen percent of SSCI respondents expect to see substantial increases in physical occupancy and nine percent expect to see substantial increase in economic occupancy. Over half expect to see slight increases in physical and economic occupancy, and nearly a quarter expect each to remain unchanged. Only 12 and 13 percent of respondents expect slight decreases in physical and economic occupancy, respectively. Only a single respondent expects significant occupancy decreases.
    
Here again, confidence levels show substantial increases over first quarter findings, with nearly 66 and 63.3 percent of respondents forecasting increased physical and economic occupancy, respectively. In the first quarter only 45 percent and 32 percent expected increased physical and economic occupancy, respectively.

Given the short-term nature of self storage leases, occupancy rates are a sensitive measure. Self storage owners and investors seek the stable cash flows that high occupancy rates provide along with other investment criteria such as affordable capital and low operating costs. Sonne points out that, “Self storage is a very local business. Within the same cities, there are winners and losers in terms of trade areas. Market fundamentals, such as supply and demand, become even more important in recessionary economic conditions. The facilities in stable markets with fair share market penetration will continue to cash flow well. On the other hand, facilities in over-supplied markets will continue to struggle pending a growth cycle in the macro economy.”

Financial Concerns

Low interest rates enable investors to pay top dollar for real estate assets. The demand for cash-flow generating property has decreased real estate capitalization rates in recent years. Interest rates remain low, and all indications are that the Federal Reserve continues in its willingness to stimulate the economy through rate cuts. It makes intuitive sense that real estate investors’ decision making is sensitive to interest rates because real estate investing generally requires carrying substantial debt.

That being said, the relationship between interest rates and capitalization is not a straightforward one. The complexity of their relationship is demonstrated by our survey results. Most SSCI respondents expect interest rates to result in neutral or increased capitalization rates. A third of respondents expect interest rates to influence slight increases in cap rates and another third expect cap rates to remain unchanged. Cap rate confidence is virtually unchanged since last quarter.

Respondents report significantly greater expectations of industry sales in the second quarter. They also expect significantly greater profits than they did last quarter. According to Tran, “Everything is market-specific in our industry. The extreme example is what happened in Michigan. Not only is the Michigan economy experiencing a recession, but people were moving out of state to look for new jobs. While storage in Michigan overall is down, there are still pockets in Michigan that are doing well.”

In the first quarter of 2008, most respondents expected industry capital expenditures, or operating expenses related to property maintenance and repair, to decrease as compared with the previous quarter, but now most respondents expect capital expenditures to stay the same or increase slightly. There are somewhat greater expectations this quarter that the cost of materials will increase. This sentiment is consistent with reports of increasing inflation. Frequently maintained storage facility features include roofs, exterior paint, and paving. Compared to other real estate asset classes, typical storage operating expenses are modest.

Respondents’ outlooks remain substantially unchanged in the area of new self storage development, with 42 percent of respondents expecting development to increase slightly, 17 percent expecting no change, and 42 percent expecting either slight or significant development decreases. This outlook is evenly balanced between those predicting increased and decreased growth.

The Larger Economic Picture

The nation’s credit crisis continues, as demonstrated by continued rate cuts from the Federal Reserve, yet inflation is growing. Oil prices are at unprecedented levels. America’s construction and auto industries are in downtrends. Securitization of mortgage risks has caused chaos in America’s residential real estate and financial sectors. The Consumer Confidence Index has plummeted to lows not seen since 1973.

Fifty-nine percent of self storage industry professionals expect the national economic outlook to decrease either slightly (49 percent) or significantly (10 percent) in the second quarter. Twenty-two percent expect the outlook to remain unchanged and 19 percent expect it to increase slightly during the second quarter. Respondents are forecasting a somewhat gloomier national outlook now than they were three months ago.

Industry professionals’ second quarter expectations for interest rate trends are mostly unchanged. Twenty-three percent of SSCI respondents expect interest rates to increase slightly during the second quarter, whereas 20 percent expected slight increases in the first quarter. Fifteen percent fewer respondents expect rates to remain unchanged this quarter, and virtually the same percent (41 percent compared to 42 percent last quarter) expect rates to decrease slightly. Seven percent of respondents now expect significant decreases, up from two percent last quarter.

The quarter-to-quarter changes, while small, are trending in opposing directions with fewer respondents predicting no change, and more respondents predicting both increases and decreases. This likely reflects continuing uncertainty about how the economic slowdown will play out with regard to availability of capital.

As mortgage-backed securities stumble as a result of sub-prime lending practices causing foreclosures, financial institutions are under fire for their failure to adequately manage risk. In reaction, or overreaction, to both this criticism and their very real fiscal crises, lenders have tightened access to credit at the same time that the Federal Reserve is loosening access to capital. This is a confusing state of affairs for real estate investors, who are strongly reliant on the availability of capital to finance investments. This uncertainty around interest rates is likely to continue in the near-term.

Larger Economic Trends And Forecasts

How can we understand self storage industry professionals’ optimism about industry prospects? Economic slowdowns can lead to change that benefits storage, including downsizing homes and moving from homes to apartments. According to Tran, in times of slowing growth, “People tend to look at their current operations and try to find ways to improve performance to drive the bottom line if they are not able to do so through acquisitions. When the economy experiences a slowdown like we are now, storage is a benefactor due to the movement in the economy—whether good or bad. Look at the REITs, they all experienced positive growth in net operating income from Q4 2007 versus Q4 2006.” 

The major driver of self storage industry health is population growth, which is projected to continue at roughly the equivalent rate as new project development. That is likely to lead to stable occupancy rates. Demand for land is limiting growth, positively influencing rental rates. According to Sonne, “Self storage has tended to hold up in bull and bear economic cycles better than other real estate asset classes.” 

The self storage industry can be sensitive to job loss and its impact on relocations.  Recent job loss increases reported by the Department of Labor for the first quarter of 2008 could indicate that national economic trends may have more of an impact than currently anticipated on our industry. While it is too soon to tell whether the self storage industry as a whole is vulnerable to the slowdown being experienced in the rest of the economy and especially in other real estate asset classes, caution may be in order. It will be interesting to see where industry confidence is trending in the third SSCI. Stay tuned!

About The Self Storage Confidence Index

The Self Storage Confidence Index measures the outlook and sentiment of self storage business professionals in various aspects of the industry regarding economic conditions and trends that affect self storage. SSCI responses are generated from an online survey of self storage owners and vendors. The second quarter SSCI is only the second such installment, last quarter’s survey having been the first ever. The survey is available each quarter at www.selfstorageconfidenceindex.com.