How has the stock market been treating you recently? Has your stomach recovered from that drop off a cliff a few months ago? What a ride.
That type of unpredictable, uncontrollable, world event influenced volatility is one of the reasons I and many other investors prefer tangible assets that are minimally correlated to the stock market. Especially ones that allow me to easily diversify, as well as produce meaningful and reliable cash distributions.
In addition to apartment complexes, I like to diversify my investments into self-storage properties which is another asset class that provides superior returns, diversification, and the ability to weather economic downturns.
The self-storage industry has a unique background to it. It started growing in the 1960’s, but truly dominated by small time owners. It wasn’t until relatively recently that large sophisticated organizations, like Public Storage and ExtraSpace entered the space. Despite the consolidation that has happened by the large player, it’s still a very fragmented asset class with significant opportunities to work directly with small operators.
The impact of the sophisticated chains has been to increase customers’ expectations. Security, easy 24/7 access, climate control, and other amenities are now the norm in most large markets. The quality of the real estate and the efficiency of the operations has increased. The great returns associated have self-storage have kept pace, and where it was once an industry with very little institutional capital, the secret is out. Today you can easily participate in self-storage via publicly available REITs. This sector has been a top performer with a good track record of growth and steady dividends.
Just like our apartment complexes, success in self-storage is a factor of supply vs demand. We look to buy in areas that are experiences steady population growth, with minimal competition from other storage properties. One result of the increased sophistication of the operators is building storage properties closer to city centers. This is in response of the increased urbanization of younger Americans, including families, who realize their apartments can’t accommodate all of their belongings.
We also see a surge in technology adoption, from the security features, to automated leasings and payment collection: there are some storage unit renters who we will never meet in person as they conduct the entire lease and access process using our automated systems.
Considering that macro view of the self-storage industry and associated trends, here are five reasons I like including self-storage properties as part of my investment portfolio.
1 – Of course it has to be the returns. According to the National Association of REITs’ annual index, from 1994 to 2021 self-storage produced an average annual return of 18.83%. For comparison here are the returns from some other REIT sectors during that same time:
S&P 500: 8.55% (https://dqydj.com/sp-500-return-calculator/ )
Let’s put that in real dollars just for fun. $100,000 invested invested into a self-storage REIT in 1994 with earnings reinvested would be worth $12.5 million at the end of 2021. $100,000 invested in the S&P 500 during the same time period would be worth $994k. That’s a huge difference! Sure, we have to add the caveat that past performance is no predictor of future success, but that’s a long enough time horizon and large enough difference that makes this asset class worthy of our attention.
2 – Downside protection. An interesting this to look at is how assets perform during recessionary periods. Looking at the annualized returns, we can see that from 2007-2009, our last downturn, and a major one, self-storage average annual returns were 3.80%. Here’s how those other sectors performed during that same period:
S&P 500: -22.03% (https://dqydj.com/sp-500-return-calculator/ )
You have to agree that’s pretty incredible. And again, the lack of correlation with the stock market is attractive. When you stop to think about why self-storage does well in both scenarios, it’s pretty logical. During good times, people buy more stuff and look for somewhere to store it. During bad times – downsizing, foreclosure, divorce, death – households seek out storage units while in transition.
3 – Opportunities for rent growth. Just like moving apartments is a hassle, so is clearing out a storage unit. These tenants are not overly price sensitive. They’re more focused on the storage unit being conveniently located to their regular living routine. Unlike apartments which at most allow for rent increases upon yearly lease renewals, storage units are rented month-to-month. This allows our operator partners to adjust quickly to market demand and maintain optimal occupancy.
4 – Cash flow. Just like our strategy with apartments, we buy storage properties that are already performing at a respectable level. This means there is cash flow from day one of ownership. Cash flow in the 8-10% annual range is pretty typical. The income is offset by large deductions such as depreciation which results in tax benefits during the hold period as well. (Our limited partners fully participate in these pass-through deductions, which is not the case with REITs.)
5 – Lots of small operators. Despite the entrance of the large brands, over 70% of self-storage properties are still owned by “mom and pop” owners. Yes, there is increased competition from the institutional buyers/operators, but the top six public companies control only about 20% of the self-storage market, with the rest controlled by independent owners. For a value-add operator, like us, this provides opportunities to identify underperforming properties that we can buy at attractive prices, modernize, and provide fantastic returns to our investors. As these properties are optimized, they become very attractive to the large institutional buyers, like REITs, who are regular buyers for us.
Just like in stocks, diversification in real estate is important. We accomplish that by investing in different asset classes, markets, and with different operators. Of those factors, choosing the right operator team may be the most important, which is what we specialize in. When buying the right asset at the right price with the right operator, the potential returns are incredibly exciting.
We admittedly offer more multifamily investment opportunities than self-storage, but we see them as an important part of our offering package. So when you see a new deal alert in self storage that piques your interest, be sure to respond to let us know you’re interested and we’ll be happy to spend time with you to dive into what about the deal gets us excited.