Q1 in Self-storage: Stay strong, self-storage!

Self-storage has gained much traction in recent years, being needs-based: the sector’s ability to shrug-off most demand damage during recessionary periods yet still enjoy modest-to-above-average returns during eras of high mobility & migration offer a distinct value proposition relative to its more cyclical counterparts in commercial real estate.

Note that throughout this series we will be following 5 listed self-storage REITs: CubeSmart (CUBE); Extra Storage Space (EXR); Lift Storage (LSI); National Storage Affiliates (NSA); and Public Storage (PSA).

This report at a glance:

  • Momentum from 2019 was carried over to Q1 as stable occupancy & rent hikes drove steady-state NOI growth (+1.1%).

  • March was however a different story, as occupancy & collections both deteriorated courtesy of COVID-19, auguring more hurt to come in Q2 (although May & June numbers show signs of life).

  • Supply pressure is seen to slightly ease as the development cycle slows; any tangible impact to street rates (if any) will likely be more apparent by 2021, however.

  • COVID-19 has accelerated the need to automate & make contactless the revenue cycle, and we anticipate higher premiums to be placed on this end moving forward.

  • As cloudy as the forward environment is, quarters ahead are likely to be less-than-stellar; SS REITs have the balance sheets to stomach this, unlike smaller operators, supporting our outlook for more consolidation soon.

Q1 topline was smooth-sailing, as occupancy remained stable

Extending 2019’s robust rental activity, Q1 self-storage revenues held steady, with like-for-like topline expanding by a respectable 2% YOY. This came on the heels of decent 2-3% rental escalations over the quarter, coupled with 50-100 bps improvement in occupancy rates for the first two months. Unfortunately, COVID-19 happened; by March-end, occupancy was down by 20-100 bps across the sector, although we note that the quarter-average remained comfortable, staying north of 85%. Without any item from the cost side that jumped significantly, mean NOI growth was strong at 2.1% for Q1.

Brace for a pandemic-shaped blip in Q2 P&L

As mentioned, mobility became an issue by late March, as lockdown restrictions were put up in response to rapidly rising COVID-19 cases. This translated to lower rental volumes during the tail-end of Q1. Firms confirmed that the trend fully spilled-over to April; National Storage (NSA), for instance, reported a ~28% decrease in both move-ins & move-outs for that month. This has since improved by May with move-in & move-out activities turning more favorable for that month. Case in point, Life Storage (LSI) observed a 3% improvement in move-in volumes and, more importantly, a 12% reduction in move-outs during May. Needless to say, there are signs of pick-up in some localities, at least in terms of core demand for self-storage, even with some underlying drivers (e.g. school closures) suppressed. In fact, what’s likely to be more of a pressing concern over the next few quarters would be the stacked topline damage with most operators halting rent hikes & auctions during the majority of Q2. As quarantine restrictions get extended instead of relaxed, this topline damage gets exacerbated alongside higher vacancy & delinquency risks.

The upside to having rental activity firm-up as early as May is that operators have greater legroom to resume rent escalations and reopen auctions sooner rather than later, evident with all 5 self-storage REITs under our radar gearing towards this by as early as the second semester. If the pace of recovery seen in May continues, gradual reversion of rental rates & volumes to pre-COVID levels by year-end is not as far-fetched as in some industries (e.g. retail) which so far largely remain underwhelming.

New supply expected to lose steam—finally

New builds are expected to taper off moving into Q2 from their strong 2020 start as the (1) overall demand landscape gets clouded by the pandemic and (2) access to capital becomes relatively tighter. Cube Smart voiced out that a chunk of the weakening may also be attributed to disallowance of construction activities in coronavirus hotspots. It might be too early in the year to tell if the supply situation has truly reversed for the betterment of street rates (or if it will be evident in 2020 at all), but the slight delay in deliveries will alleviate near-term supply pressure, which was a primary concern in previous years especially in then-active development areas (i.e. New York, Seattle, Nashville).

A key angle to consider parallel to this is in acquisitions: operators have deferred purchase of wholly-owned units that they have previously outlined to complete by 2020, in the name of cash preservation & financial flexibility. Overall guidance has shifted in tone from being aggressive in purchases (as was the case in 2018 & 2019) to being more selective and opportunistic. The silver lining is that there may be more of these opportunities gathering in the horizon, as tight credit & softer NOIs push smaller (and especially leveraged) players to exit.

A push and shove to automation

While there has long been a consciousness that automation and other high-tech value-adds are crucial to playing the long game in self-storage, the COVID-19 crisis has accelerated the need for operators to upgrade their management systems. Contactless solutions have never been more relevant as they are today, and those that have made earlier pivots towards this space, such as Cube Smart via SmartRental, have reportedly enjoyed 100% collections since release in April. Likewise, National Storage and Life Storage benefited through higher customer mix subscribed on autopay, limiting their exposure to the downside in collections (which decreased by 100-200 bps during the period). We expect exciting corporate movements on this end (i.e. more capex funneling towards tech upgrades) to counter the demand damage brought by COVID-19. We also reiterate that spending on these items is inevitable anyway, and the fact that self-storage can automate the entire revenue cycle highlights a core strength that is little, if at all, seen in other sectors in commercial RE.

Self-storage sees cloudy rest-of-the-year; but who doesn’t?

The pipeline for later will likely be enough to sustain balance sheets (as mean debt-to-assets sits manageably south of 50% & net debt to EBITDA is at 4.8x). From a different vantage point, today’s uncertainties are causing jitters in smaller & localized operators, which may lead to elevated levels of transaction activity post-COVID. It thus makes more strategic sense to earmark capital ahead of this expected consolidation, although again, much of that will be riding on the velocity of the recovery in the coming quarters.


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