By Allison Landa

Self-storage REITs are coming of age. In recent years, the sector has recovered from tough times, pushing forward to become what analysts consider to be one of the most promising segments of the commercial real estate market. Analysts say that even though oversupply made the sector turbulent in the past, it’s been tempered by higher short-term interest rates that serve to limit development.

“Self storage is an attractive business model that has seen significant growth,” says Michael Knott, an analyst at Green Street Advisors, Inc. “It has become part of the fabric of the consumer economy as awareness of the product has increased.”

Self Storage
# of REITs	4
Industry Market Cap (in thousands)	$22,231,467
% of Industry	5.4%
Yield	2.44%
YTD Total Return	10.66%
One-Year Return	40.95%
Three-Year Return	29.40%
Five-Year Return	.56%
Average Daily Trading Volume (Shares)	284,511

Overall, Knott says, the sector has seen continued growth throughout the past three decades—an expansion encouraged by consumer storage needs. “Self storage benefits from demand stemming from myriad life events, such as marriage and job transfer,” Knott says. In 2006, the higher cost of single family homes and the concomitant rise in apartment demand also increased the need for storage.

According to Raymond James & Associates, the number of U.S. self-storage facilities has grown nearly 70 percent in the last decade, at a compound annual growth rate of 5 percent. There are four publicly traded self-storage REITs: Extra Space Storage, Inc. (NYSE: EXR), Public Storage (NYSE: PSA), Sovran Self-Storage, Inc. (NYSE: SSS) and U-Store-It Trust (NYSE: YSI). Together, these companies comprise slightly more than 8 percent of all self-storage properties, but considerably more when analyzed on a square-footage basis.

Rick Murray, an analyst at Raymond James, says the preponderance of smaller companies leaves the self-storage sector one of the most fragmented among commercial property types. “Most properties are still owned and/or operated by individuals,” he says. “Therefore, we think continued consolidation by public REITs is very likely.”

In recent years, individually owned self-storage properties were swallowed by their REIT brethren. One example is the privately held Evergreen Realty REIT, Inc., which has been active in acquiring smaller properties. In June 2005, the REIT bought two San Antonio self-storage facilities—Attic Self-Storage Laredo and Attic Space Blanco Road in a transaction valued at $5.1 million.

The sector’s larger REITs also are buying one another, as evidenced by Public Storage’s acquisition of Shurgard Storage Centers, Inc., completed in August 2006. In a transaction valued at $5 billion, Public Storage assumed approximately $1.8 billion of Shurgard debt and issued approximately 38.4 million shares of common stock. As a result, Public Storage manages more than 2,100 self-storage facilities in 38 U.S. states and seven European countries, totaling approximately 132 million rentable square feet.

However, Knott doesn’t see consolidation as heralding an end to the mom-and-pop portion of the sector. “I doubt you’ll ever see REITs having market share of more than 30 percent to 40 percent,” he says. “Yet, it is true that big institutions view the sector more favorably than five or 10 years ago.”

Knott cites the July 2005 acquisition of Storage USA—a company acquired through a joint venture between Extra Space Storage, Inc., and Prudential Real Estate Investors—as an example of self storage becoming a more serious consideration for investors.

The $2.3 billion transaction brought Extra Space’s portfolio to more than 630 properties nationwide. “The sector is seen as a more legitimate investment than in the past,” Knott says.

Merrill Lynch Senior REIT Analyst Christopher Pike agrees that consolidation is picking up steam in the sector. “We have seen significant consolidation amongst both public operators and private operators,” he says. “While the consolidation across private players may be a prerequisite for a possible IPO, the public companies are acquiring larger portfolios and companies for economic synergies, given the relatively management-intensive nature of storage.”

Pike says the sector is largely characterized by its clientele. “I view self storage more along the lines of consumer discretionary, driven by population growth and local demographic trends,” he says. “In our research, we found that local, affluent consumers are better for the storage landlord.”

Still, Pike cautions against generalizations, saying that the sector’s success comes down to strategy rather than simple dollar expenditures. “This does not mean that only ‘A’ assets in ‘A’ locations will perform well,” he says. “Similar to apartments, it is all relative. A well-positioned ‘B’ asset with relatively solid demographics and operating efficiencies can also perform well.”

Sector Benefits

Analyst John Sheehan of A.G. Edwards & Sons says stable cash flow, high operating margins and low capital expenditures are all ongoing sector benefits. “I view self storage as an attractive asset class,” he says. “Over time, I expect self-storage REITs to continually increase their market share through both acquisitions and developments.”

Sheehan, however, cautions that low construction costs present a downside. “Self storage is a relatively low-cost asset class to construct, which can make it somewhat easy for new competitors to build properties,” he says.

Knott considers self storage’s relatively low barriers-to-entry as the sector’s key challenge. “However, as the business has gone from building in industrial areas to increasingly building in retail corridors, it has become tougher than in the past to build storage units,” he says. “This is an issue in metro areas like Southern California.”

Price stability, according to Pike, has served the sector well. A storage-unit client himself, he has seen rent increase by 8 percent over the last year. His monthly storage fee is now equivalent to two venti lattes at Starbucks. “From an operating perspective, one advantage that storage has over its property-type peers is that its demand is relatively inelastic in respect to change in prices” he says.

For his part, Murray says that fluctuations in the overall economy will be the sector’s ultimate proving ground. “The big challenge for the sector, and for all real estate sectors, will be the performance of the economy and whether or not we see a shift to a slower growth mode,” he says. “Barring a recession, we think the self-storage sector should continue to perform well in the foreseeable future.”

Overcoming the Oversupply

Murray notes that self storage has historically fallen victim to overdevelopment, given the relatively low cost of this property type, as well as a short time horizon needed for new developments. “This remains a risk today,” Murray says. “However, to date we have seen modest supply growth, and we expect it to remain manageable.”

Murray predicts that recent increases in short-term interest rates will play a strong role in keeping supply growth at a more effectively controlled level. “Higher rates make it more difficult for smaller developers and operators to build facilities, since they are heavily reliant upon short-term debt financing,” he says.

However, Pike believes that fundamentals are a more interesting factor for the sector than development—specifically, the impact of a softer housing market and weaker economy.

“Some operators have publicly stated that their operating platforms are relatively resilient to most scenarios except for significant economic shocks, such as the Sept. 11 terrorist attacks,” Pike says. “However, if the sector is truly linked to consumer discretionary factors, a weakening economy may impact fundamentals. At the same time, a recession may cause a multitude of situations that could increase demand for self-storage space, not to mention the usual suspects, such as divorce, marriage, job transfer and relocation.”

Pike sees the sector’s main challenge in stark terms. “Supply, plain and simple,” he says. “The type of unit being supplied could also lead to longer lease-up periods and lower rents. For example, if development is rolled out in a generic manner, not taking into account local consumer demands, needs and preferences for unit size, storage type, and other factors, the bid for storage may not be there.”

Finally, Knott says the unique character of the sector’s economics will keep smaller businesses afloat even as self storage continues to grow on the whole. “Economies of scale inherent in self storage should result in larger owners getting even bigger in the future, but it remains a business that local entrepreneurs can enter and make a living as a small operator,” he says.