KORPACZ REAL ESTATE INVESTOR SURVEY

Transcription

1 KORPACZ REAL ESTATE INVESTOR SURVEY Second Quarter 2005

2 Making News This Quarter National Highlights Useful Websites Property & Geographic Preferences Technology News & Trends Economic News Real Estate Capital Markets Special Report: Domestic Self-Storage Market SECOND QUARTER 2005 VOLUME 18 NUMBER 2 COMMERCIAL MARKET REPORTS National Retail Markets Regional Mall Power Center Strip Shopping Center Office Markets National CBD National Suburban Atlanta Boston Chicago Dallas Houston Los Angeles Manhattan Pacific Northwest Philadelphia San Francisco Southeast Florida Washington, DC Metro The District Northern Virginia Suburban Maryland National Flex/R&D Market National Warehouse Market National Apartment Market National Net Lease Market National Development Land Market (semiannual) Investor Survey Response Tables Investment and Property Market Characteristics Office Markets National Markets Yield Comparisons Dividend Comparisons Institutional-Grade vs. Noninstitutional-Grade Rates Income Capitalized in Direct Capitalization Holding Periods and Growth Rate Comparisons Definitions Industry News

3 10 Domestic Self-Storage Market THE MATURING OF AN INDUSTRY - PRICING AND PERFORMANCE TRENDS By Charles Ray Wilson, CRE, MAI Chief Economist, Self Storage Data Services, Inc. Chart 1 O VERALL CAP RATE TRENDS (Portfolio and Individual Facility Sales) 9.5% 9.0% 8.5% 8.0% 7.5% 7.0% 6.5% 1Q03 2Q03 3Q03 4Q04 1Q04 2Q04 3Q04 4Q04 1Q05 WITH COMPETITION FOR PREMIUM LO- What will drive demand in the future? CATIONS AND CUSTOMERS INTENSIFYING As a result, the self-storage industry appears to be at the end of its beginning. IN THE DOMESTIC SELF-STORAGE MARKET, THIS SECTOR IS COMING OF AGE. During Prior to the most recent recession, the past 30 years, self-storage facilities self-storage utilization was believed to have been built in order to satisfy pentup demand of unknown portions. Alments. For the first time in its relatively be recession resistant, much like apartthough occasional periods of oversupply short history, however, the self-storage existed during the past three decades, sector felt the impact of the latest recession. Now, there is strong reason to be- an upswing in public awareness i.e., demand eventually absorbed any oversupply. While the adage build it and performance will more closely track lieve that this sector s future operating they will come held true for the past changes in the overall economy. As a three decades, it no longer holds true in result, yield rates will come down from many individual self-storage markets. their historical high levels and will remain more competitive with other Several years ago, there were hundreds of households for every self-storage unit in the top 50 largest markets property types going forward. (i.e.,100:1). Today, there are only ten CURRENT INVESTMENT MARKET households for every unit (i.e.,10:1). As CONDITIONS the ratio of households to units continues The stellar performance of many selfstorage real estate investment trusts to decline, it appears that this sector s pent-up demand has been satisfied. In (REITs) over the past ten years has helped fact, a soft operating performance over convince numerous individual investors, the past two years has caused both as well as institutional ones, that investing in self-storage assets was an lenders and owners to seriously question, opportunity whose time had come. Self-storage assets, like most other property types, have benefited from the shift of capital from the stock market into real estate. Many investors see self-storage real estate as a relatively low-risk, high-yield investment opportunity. Three major factors have contributed to the extraordinarily strong self-storage investment market over the past couple of years: a) Existing publicly traded REITs, whose stock prices and liquidity have been buoyed by both low interest rates and strong earnings, have increased their property acquisitions. This factor has been punctuated in the last six quarters by aggressive and competitive acquisition programs of two new REITs, which each sought to bulk up their portfolios prior to their initial IPOs in Their acquisition programs continue, with more than 100 properties currently in escrow by just one of the new REITs. b) 1031-exchange buyers, particularly investors moving out of apartment investments, have been selling apartments based on overall capitalization rates (OARs) of less than 5.00% and acquiring self-storage assets with OARs of 7.00% to 8.00%. c) High-net-worth individuals seeking new opportunities have been acquiring self-storage assets using highly leveraged, variable-interest-rate, shortterm debt. Some of these individuals are buying facilities currently operating below historical stabilized occupancy levels with the hope of restoring their performances. In addition to these three factors, the plentiful availability of capital at the P RICEWATERHOUSEC OOPERS

4 11 lowest interest rates in the industry s history has helped to considerably heat up this sector s acquisition side. There has never been a higher demand for selfstorage facilities by investors nor a better time to sell self-storage assets. OVERALL CAPITALIZATION RATES Despite this sector s soft operating performance during the last couple of years, capital continues to flow into it. In fact, overall capitalization rates (OARs) have been driven down to their lowest levels in this sector s history. In the past, selfstorage OARs were 100 or more basis points over multitenant industrial properties. The reason for the increase was due to the perceived risk associated with month-to-month rental agreements rather Table 1 than long-term leases. Now that the perceived risk has disappeared, the built-in risk premium once attached to self-storage OARs has vanished. Given the amount of liquidity in the markets today and the anticipated modest increases in interest rates, future self-storage OARs will likely be more closely aligned with those of other industrial properties with similar risk. The declining trend in OARs for all self-storage facilities (both investment and noninvestment grade) over the past 24 months is shown in Chart 1. As the chart shows, OARs averaged about 9.00% at the start of 2003 before declining to about 7.50% in the first quarter of Given the high prices currently being DOMESTIC SELF-STORAGE MARKET First Quarter 2005 KEY INDICATORS CURRENT QUARTER DISCOUNT RATE (IRR) a Range 8.50% 10.75% Average 10.00% OVERALL CAP RATE (OAR) a Range 6.00% 9.00% Average 7.50% RESIDUAL CAP RATE Range 8.00% 9.00% Average 8.50% MARKET RENT CHANGE RATE b Range 2.50% 4.00% Average 3.25% EXPENSE CHANGE RATE b Range 2.50% 5.00% Average 3.50% AVERAGE MARKETING TIME (in months) Range Average 7.00 % Change a. Rate on unleveraged, all-cash transactions b. Initial rate of change paid, investors are starting to pay more attention to how much of a premium over replacement cost the purchase price represents. The amount of the premium is directly related to the market s barriers to entry. The more barriers to entry a market possess, the higher the premium. INCOME CAPITALIZED IN DIRECT CAPITALIZATION Most investors currently calculate OARs based upon three, six, or twelve-months trailing net operating income (NOI). During the past 12 months, six portfolios totaling over 20 million square feet have been acquired by REITs at overall cap rates between 6.25% and 7.50% based upon trailing NOI. Since many facilities are operating at below their historical economic occupancies, many investors are paying premiums for perceived upside because they do not consider the properties incomes to be stabilized. For example, a major pending transaction involving self-storage facilities totaling more than three million square feet is reportedly transferring based upon a trailing overall cap rate in the low to mid 7.00% range. The buyers are reportedly anticipating a firstyear yield increase due to improving rents and occupancies. Self-storage investors have not typically performed discounted cash flow (DCF) analyses when analyzing selfstorage assets. The lack of long-term leases, tenant improvements, and leasing commissions meant using just direct capitalization in order to determine property values. However, with more sophisticated investors entering this industry, yield analysis is becoming more popular among investors. The results of our current survey of self-storage OARs, as well as other key indicators, are shown in Table 1. These parameters consider unleveraged, investment-grade facilities located in major S ECOND Q UARTER 2005 K ORPACZ R EAL E S TATE I NVESTOR S URVEY

5 12 U.S. markets. OARs for investment-grade facilities range from 6.00% to 9.00%. Transactions in the 6.00% range are typically for portfolios with unstabilized facilities. OARs for single-property, stabilized assets are typically in the 8.00% range, while OARs for noninvestment grade, stabilized facilities are typically over 9.00%. We will continue to track and report changes in these parameters in future issues of this Survey. SELF-STORAGE INVESTMENT ACTIVITY The pace of self-storage transactions has quickened recently as many major players have taken a more aggressive acquisition posture. Prudential Financial, Inc. and Extra Space Storage, Inc., for example, just announced that they are acquiring all of Storage USA s assets and interests from GE Real Estate for a total consideration of $2.3 billion. on closing this transaction, Extra Space Storage will become the second largest self-storage operator in the nation, based upon square footage. Specifically, it will have a total of 630 owned, managed, and franchised properties totaling approximately 43 million square feet in 32 states. This transaction is expected to close in the third quarter In published material dated May 5, 2005, Extra Space Storage noted that the overall cap rate on wholly-owned facilities, based upon first quarter NOIs, would be approximately 7.0%. In addition to this acquisition, four other portfolios located in the Washington, DC Boston corridor have traded recently. These deals demonstrate the continued consolidation that is happening within the industry, as well as the aggressive pricing structure that is occurring. In the first deal, nearly 290,000 square feet of net rentable area (NRA) sold for approximately $ per square foot. The trailing overall cap rate, which included one or more facilities that still required lease-up, was 5.8%. The buyer s anticipated stabilized, or Chart 2 SELF-STORAGE PERFORMANCE INDEX (SSPI) 4th Qtr 03 1st Qtr 04 2nd Qtr 04 3rd Qtr 04 4th Qtr 04 1st Qtr 05 forward looking, overall cap rate was 7.6%. In the second deal, four stabilized facilities totaling over 280,000 square feet of NRA sold for $ per square foot and indicated an overall cap rate of 7.2%. In the third deal, three facilities totaling about 250,000 square feet of NRA sold for about $93.00 per square foot based upon a stabilized overall cap rate of 7.0%. And in the last deal, a 235,000-square-foot portfolio sold based upon an 8.0% overall cap rate, which equated to approximately $98.00 per square foot of NRA. Combined, these four recent selfstorage transactions represent over one million square feet of space and indicate an average sale price of about $ per square foot of NRA. The trailing overall cap rate, the one most often reported, averaged 6.6%, while the forward looking overall cap rate averaged 7.3%. SELF-STORAGE PERFORMANCE INDEX As the self-storage industry has matured, the need for timely data for decision-making purposes has increased. One of Self Storage Data Services, Inc. s registered products, U.S. Self-Storage Performance Index or SSPI, measures the health of the domestic self-storage market based upon key operating statistics occupancy, rental rates, concessions, and expenses from both independently and corporately owned facilities in the 50 largest U.S. metropolitan statistical areas (MSAs). These statistics are then used to calculate a NOI per occupied unit on which the SSPI is based. The SSPI uses median values for a 100-square-foot, ground-level, nonclimate-con- P RICEWATERHOUSEC OOPERS

6 13 Table 2 PERFORMANCE AT A GLANCE Top 50 MSAs QUARTERLY SEASONAL ANNUAL 1Q05 vs. 4Q04 1Q05 vs. 1Q04 Trailing 4 Quarters RENTAL RATE CHANGE 3.6% 3.6% 0.9% PHYSICAL-UNIT OCCUPANCY RATE CHANGE Down 0.2% 0.8% 0.2% REVENUE PER OCCUPIED UNIT CHANGE 3.6% 5.5% 0.3% trolled unit as a benchmark. SSPI trends are shown in Chart 2, while the key statistics used in formulating the SSPI are detailed in Table 2. Rental Rates Based on the benchmark, the median asking rental rate increased 3.6% between the first quarter of 2004 and the first quarter of In dollar terms, asking rental rates increased from $82.00 per month to $84.99 per month during that time period. Physical-Unit Occupancy Based on the benchmark, the median physical-unit occupancy rate increased 0.8% from 89.0% in the first quarter of 2004 to 89.8% in the first quarter of Concessions During the first quarter of 2005, 69.9% of the self-storage facilities in the nation s top 50 MSAs offered some form of concessions. This represents a 6.8% increase over the 63.1% who offered concessions a year earlier. The effective cost of these concessions increased approximately 0.6%, suggesting that while more facilities were offering concessions, they had less of an impact on a facility s overall financial health due to the general strength of market fundamentals. Revenue Per Occupied Unit As a result of increases in asking rental rates, gains in physical occupancy, and a slight up tick in the cost of concessions, revenue per occupied unit increased 5.5% between the first quarter of 2005 and the first quarter of In dollar terms, revenue per occupied unit increased from $66.17 to $ CONCLUSION Given the continuing improvement in the overall economy, the positive trends occurring in employment, and the moderate pace of new self-storage construction, most operators are anticipating improved operating performance in the months ahead. Comparing performance data from the first quarter of 2005 to that of the same quarter last year suggests that improvement is indeed possible. The self-storage sector s operating performance, while below historical levels, still provides returns that continue to attract investors and that compete with other property types. As a result, the pace of self-storage acquisitions will likely remain quite brisk during Note: The Self Storage Performance Index (SSPI) and other products referenced herein are copyrighted or trademarks of Self Storage Data Services, Inc. (SSDS) and are reprinted herein with SSDS s consent. Charles R. Wilson, CRE, MAI is the founder of Charles R. Wilson and Associates, Inc., a full-service appraisal firm, and the founder of Self Storage Data Services, Inc., a leading manager and publisher of economic and operating statistics relating to the self-storage industry. For more information about SSDS, please visit their website at More information about Charles R. Wilson & Associates can be found at S ECOND Q UARTER 2005 K ORPACZ R EAL E S TATE I NVESTOR S URVEY