From Feerooz Yacoobi
While the broader US economy continues to show impressive resilience in a rapidly evolving geopolitical landscape, evidenced by a stock market near all-time highs and sustained low unemployment levels, investors may be surprised to hear of the “minirecession” that the self-storage industry has wrestled with over the past 24 months. The sector experienced significant operational headwinds in 2024, challenging the industry’s reputed “recession-resilient” nature established over past economic cycles.
Ranging from -1.5% to -5.5%, the publicly traded self-storage REITs report that 2024 marked the first decline in net operating income (NOI) among same-store pools since 2010 and the Great Financial Crisis. Entering 2025, the fundamentals of the U.S. self-storage market continue to be pressured by subdued consumer demand, driven by a housing market that has experienced its slowest transaction levels in the past 30 years.
The rise in interest rates has curtailed home sales, suppressing leasing momentum and escalating competition for new rentals among self-storage operators. With an estimated 40-50% of tenant demand originating from population mobility, rental rates on new tenants have come in 35-40% below those of existing tenants, with strategic revenue management across the tenant base required to sustain property revenue levels. It seems quite remarkable that self-storage revenues have been able to remain mostly intact given this impact on demand. While short term leases, a sticky tenant base, and revenue management practices have allowed self-storage owners to mitigate these negative influences from a stalled housing market, investors eagerly await a stabilized capital market and an increase in housing market activity.
Within our own portfolio of self-storage assets here at Buchanan, we too have been negatively impacted by dampened consumer demand. However, given the intentional profile of our investments in that of high-quality Class A assets located in infill and/or undersupplied markets, we are fortunate to have had a more positive experience. Though slower than projected at certain properties, we continue to experience positive leasing momentum and revenue growth across all assets in our portfolio, highlighting the importance of property location and trade area supply and demand metrics.
Our assets in high growth markets such as Phoenix, that are driven by population growth and new home sales, have felt the impacts from the housing market far more than our assets located in high barriers-to-entry and infill markets such as California. For this reason and many more, we will continue to focus our investment efforts on institutional quality assets in top-tier western US markets that offer favorable supply and demand dynamics.
Despite these challenges, self-storage assets have maintained above average valuations relative to most other commercial real estate property types. While negative leverage makes for a challenging acquisitions environment, recent transactions indicate that cap rates for institutional-quality properties in coastal U.S. markets are between 4.75% and 5.0%. Though many investors are sidelined with the current costs of capital, the sector continues to attract robust interest from all-cash buyers and family offices, who represent long-term investors drawn to the property type given the predictability of cash flows and potential for capital appreciation – provided by a needs-based product with a diverse tenant base and high operating margins coupled with low capital expenditure requirements. In addition, we are noticing investors increasingly reallocating from more volatile sectors, such as office, and into higher-performing niche property types like self-storage.
Given the decline in rental rates across most markets, paired with elevated financing, construction and land costs, developers face major challenges in securing capital for new projects in the current environment. The new construction supply pipeline is rapidly dwindling as legacy developments are now being delivered and there is little in terms of new projects to backfill. At Buchanan Street Partners, we are capitalizing on these current market dynamics by actively pursuing ground-up development projects ourselves. We target high barriers-to-entry markets that offer continued rent strength, supporting development yields 200+ basis points above current market cap rates. We believe that these opportunities offer an attractive risk-return profile and feel that developing into an environment with a minimal amount of new competing supply being delivered over the next few years will prove to be a sound investment strategy, particularly as capital markets and consumer demand within the sector stabilize. While we continually evaluate acquisitions of stabilized cash flowing assets, today’s market environment lends itself more conducive to new construction and pre-stabilized acquisitions for outsized returns within the sector.
It is our belief that elevated interest rates and the consequent constraints in the housing market are cultivating a significant amount of pent-up demand for self-storage space. Self-storage benefits when people move due to various life events—marriage, divorce, new jobs, home resizing, retirement, and even death. Presently, affordability challenges are causing many to delay their housing transitions. However, this delay can only be temporary, and life’s milestones will inevitably compel individuals to move out of necessity. This will result in a considerable increase in self-storage demand. For this reason, we are confident that investors with the conviction to invest through these challenging times will look back and be pleased with today’s entry point for new investments, as opposed to asset pricing when consumer demand has stabilized, rent growth and occupancy strength return, and there is greater investor competition with increased capital flows. Though it is easier said than done, we want to be investing in an environment when most others are not.