Passive Investment Paper
The SSAA position on Passive Investment in Self Storage
The growth of the Self Storage Industry in Australia and New Zealand has seen the development of a number of methods of passive investment in the industry. Various property trusts have been associated with the industry over the last 10 years or so. There have also been self storage strata schemes that began appearing in Australia in the early 90’s. The majority of these strata schemes have had limited success in terms of ongoing viability as self storage businesses, with a number of high profile failed projects in recent years. The SSAA has developed this paper as an overview of the risks associated with investing in self storage along with considerations for potential investors before committing to the industry as part of their investment strategy. The SSAA does not endorse or condone one sort of investment model over another for the self storage industry, but has a view that investors should be as fully informed as possible.
This paper gives an overview of the self storage industry and some of the risks of investing in such.
Background on the industry
The typical self storage investment model usually involves an operator securing the freehold or leasehold of a property, developing and operating a storage centre. Storage centres vary in size and can range in size from a handful of units to over 1000 spaces in some markets. The centre would have a range of unit sizes available for the numerous customer needs. Most customers are short term and demand for sizes depends upon the local demographics of the area.
The self storage industry is very competitive. The number and quality of competing operators in a market area will have a huge impact on prices and occupancy of a centre. There are limited barriers to entry for new competition other than the capital costs of acquiring the real estate and developing the site.
Freehold investment of property has traditionally been the most common investment option for self storage operators although a number of successful Self Storage businesses have been established on leasehold properties. Typically, for the leasehold model to work, leases of 15 – 25 years are required with a relatively stable rent increase model over the term.
Self Storage Investment Risk Fundamentals
1. Occupancy Risk - Self storage has significant exposure to vacancy. This is caused by competition and oversupply as well as local economic factors. The annual statistical study undertaken by the SSAA reveals that average occupancy in all of Australia and New Zealand was just under 80% in 2011 and has dropped over the last couple of years. That means that more than 1 out of every 5 units is vacant at any time. The rent-up of a newly built storage centre can take several years depending upon how large the centre is. It is fairly typical to take 3-4 years to rent-up a 400–500 unit storage centre.
While self storage does attract some long term customers that hold onto their unit for many years, approximately 50% of customers are typically short-term and need the service as an interim measure only. This means that most storage units do not remain occupied for long periods and will suffer transitional periods of vacancy.
The Manager of the property will have a major impact on the occupancy of the storage centre and a particular storage unit or size. Their level of training and sales skills are critical in this regard. Any passive investor in the industry should ensure that their investment arrangement has a method of monitoring management performance to agreed objectives and appropriate actions for under (or over) achieving these goals. Investors in strata storage units should expect vacancy in their unit through the normal turnover of customers and due to supply issues in the local market. Ultimately, the manager and management system are the single most important variable that can affect the success of a Self Storage facility once it is constructed.
2. Storage Price Risk - Storage prices are volatile depending upon current competition and market conditions. Rental Guarantees offered to investors should be checked carefully with the local market and competition. A simple ring around of the local operators will give an investor a fair idea of the state of the local market. If market prices are lower than the proposed rent, and incentives and discounts are being offered to win business, then this should be considered in the analysis by investors. If guarantees of rental income are higher than the existing market rate, then rent decline after the end of the guarantee is likely. Oversupply of storage space is the most common factor that will push prices downward and cause excessive vacancy.
Once again, the Manager of the storage centre will be the critical factor in setting the prices that the storage units will be rented for.
3. Secondary Market Risk - At this time, strata storage units do not have a significant secondary market for the trading of the unit after initial sale from the developer. Given this type of investment opportunity has been available for around 10 years it could be expected that a secondary market would have been established although there still are very few strata storage properties on the market. It is possible that a secondary market may develop in the future if more stable and long term strata self storage developments occur. Investors should consider that their ability to realise and exit the investment might be difficult and the impact this has on the liquidity of such an investment.
4. Outgoings and Fees - The operation of a self storage centre has substantial ongoing expenses. These include advertising, wages, insurance, taxes, rates, electricity, repairs and maintenance, management fees, training, stationery and so on. In assessing the return on investment an investor should make themselves comfortable that all the expenses are disclosed, known and considered.
5. Industry Average Return on Investment Estimates - The SSAA does not provide or offer any estimate of the average Return on Investment. Investors have their own risk and return profiles and should consider all the risks associated with self storage as outlined here and in the local market area. Different locations, different demographics, competitive markets and the varying quality of the storage centres, should all command different risk premiums for investors.
6. Industry Growth - The self storage industry in Australia and New Zealand is still young and in an initial growth stage, although in the last 3 years this growth has noticeably slowed. The SSAA has been collecting data on the growth of the industry for over 12 years and while this does give a good historical picture of the industry, it is still in its infancy phase and any figures on the future demand of the industry remain speculative. Evidenced by the decline in growth of the industry since the global economic downturn. Only once the industry has reached a level of maturity will more accurate predications of demand be obtainable, when this maturity will be reached is also speculative at this time. The SSAA does not endorse any given forecasting method for the growth of the industry for this reason.
7. Location Risk - The success or failure of a self storage centre can be very dependent on its location. Well-located storage properties will be more likely to survive oversupply and economic slowdowns. It is commonly accepted that locations with high exposure and visibility to passing traffic, with good access and few competitors are considered premium. Poorly located properties are likely to be more adversely affected by changes in the market due to increased competition.
Potential self storage investors are advised to research the industry and the individual investment thoroughly, before investing in the industry, particularly through passive methods such as strata schemes. This includes close analysis of the local market in which the investment property resides. Incentive schemes such as rent guarantees should also be fully investigated to ensure that they reflect the true return of the investment. Investors should make themselves comfortable with all the risks and the local market conditions of supply and demand. These characteristics will impact vacancy levels and pricing in the market. When considering the financial reports of a potential investment always ensure that proper consideration for operating expenses has been made.
As with any significant investment you should seek independent advice on the nature of the market in relation to your investment. There are a number of consultants who specialise in the industry and will provide advice based on a selected local market. The SSAA also produces two publications of interest to investors - The Almanac, detailing key industry statistics and the Demand Study, Australasia's most comprehensive study of current and potential users of self storage, to determine likely levels of future demand for the product.
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