What Are The Likely Effects Of The End Of The Fed's Series Of Dramatic Interest Hikes On Self-Storage Valuations?

By Anthony Piscitelli

Dramatic interest rate hikes have taken a huge bite out of commercial real estate deal volume. But self-storage is proving to be resilient against the onslaught, albeit with valuations that have eased off their pandemic-era peaks. 

Most industry participants by now know the narrative: The pandemic drove the industry to new heights, with near-zero interest rates and increased demand on the consumer side. 

Meanwhile, major private equity players and funders witnessing these trends in the marketplace began flooding the marketplace in a significant way. Blackstone and other investment groups drove valuations for properties to new heights, creating new demand and the highest transaction volume in the history of the industry.

We all saw the market cool as interest rates increased. Buyers who were more debt-reliant – pulled back on new investments in commercial real estate in 2022 and 2023.  Major private equity firms reduced investment volume as redemption notices from investors piled up.

That contraction hit more than a year ago, but 2023 has seen even more shifts to the market. In August, Life Storage Inc announced that they had successfully acquired Extra Space, meaning that the country’s second and third largest self storage companies were now one. With the dust still settling on the acquisition, REITs haven’t had the same impact on the market as they once had, leading sellers to question the future of the marketplace. 

So overall, valuations are lower, and would-be sellers are concerned. The question they’re asking: What does a sale in today’s market look like, and how can they be sure they’re optimizing returns on their property?

The good news for all participants is that self storage, unlike a lot of other commercial real estate sectors, has shown a great deal of resilience in this downturn. While office buildings and shopping retail spaces are suffering from major post-pandemic vacancy issues – office space in particular seems to be on the edge of a leasing-demand cliff – the average self-storage occupancy rate in 2022 was a very robust 93 percent. 

And though the sale rate and scope of sales have gone down since their record 2021 highs, the fall is more of a plateau than a plummet with roughly $10 billion of storage property sales in 2022 – down from the pandemic-era high of $12 billion, but by no means a market collapse. 

Still, with the Fed cranking in eleven rate increases in the last twenty months, there’s been an expected drop in deal volume. The acquisition of Life Storage has done a good deal to keep major players on the sidelines, while other buyers chose to see if they could wait out the interest rate hikes. 

But by the spring of this year, it became clear that the interest rates weren’t going to go away quickly. Buyers started to emerge more from their bunkers and the market started to come to life again. 

A good chunk of the sales that we’ve seen in the last few months have been those from motivated sellers; these tend to be smaller facilities who have owned their units for 20 or 30 years, now looking to retire. With a desire to exit the space, and in many cases, begin retirement, the motivation isn’t there to wait it out for another four or five years in the hope that valuations will spike again. 

While they won’t be able to get the deal they might have been able to back in 2021 anytime soon, they’re certainly sitting on a lot more value then they were pre-pandemic. 

The other deals still finding success are those that involve high-quality assets. Units that have stable revenue in core markets are finding ready buyers. In hot-spot areas in certain parts of Texas and Florida, for example, deals are getting done that generally involve newer builds that are still filling up.  

Buyers do see a few cautionary signs: Nationally, rents are growing much slower by around 2%-4% over the past year. The one bright side for buyers is that with high interest rates, not as many new builds are popping up. The debt required to finance a new build is simply too pricey for many developers right now, meaning that from a supply and demand perspective, we may have reached equilibrium in many markets. 

So the valuation game is different than it was during the COVID fever. Sellers whose expectations remain stuck in 2021 are likely to experience some disappointment. But with the right product in the right markets – and with expectations tempered a bit by the last 20 months, the market for self storage remains strong.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.