Size Matters

September, 2012

In the commercial real estate world, self-storage is undergoing a period of enlightenment, as evidenced by the several hit reality shows on the topic that are popular on TV today. These shows have raised the profile and awareness of the industry, even if their "pot of gold" premise is somewhat misguided based on the realities that we, as industry professionals, truly understand.

While self-storage's role in pop culture has made it seem glamorous, the solid historical operating performance of this asset class is what truly makes it stand out. Few commercial real estate investments have proven to be as resilient as self-storage. As a result, the secret is out, and both lenders and investors have opened their eyes to what has been long considered an offbeat and niche property type.

The purpose of this article is to explore some of the trends that drive the self-storage industry today and to assess the impact that size has on these trends. One adage dictates that "bigger is better," while another suggests that "good things come in small packages." The intent here is not to pick winners, but rather to explore the different variables that impact self-storage operators based on size. These variables include access to capital, utilization of sophisticated technology, and economies of scale. At first glance, larger operators seem to have an overwhelming advantage; however, smaller operators can offset these advantages and even outperform their larger counterparts.

Evolution and Consolidation

Self-storage is a relatively immature industry whose US roots only date back to the 1960s. The industry grew slowly through the 90s, when consumer awareness increased and demand outpaced supply, resulting in a rush of new self-storage developments. As a result, one of the most active periods for this industry occurred between 2000 and 2005. Over 3,000 new facilities were built every year during this time. According to the 2012 Self Storage Almanac, as of 2011, 50,048 self-storage facilities were operating in the US.

In terms of square footage, the following graph, recently published by Sparefoot, effectively illustrates the magnitude of growth.

Despite its popularity, the industry is still highly fragmented. Today, the top 5 operators own less than 20% percent of the facilities, with the rest run by smaller operators, as shown in the figure below. Conventional wisdom suggests, however, that of the estimated 50K facilities, only somewhere around 50% would qualify as "institutional quality" facilities, or facilities over 60K SF with a full suite of modern amenities. While the fragmented nature of the industry provides the ideal environment for consolidation, it seems likely that the major markets and institutional collateral that will most influence this process, at least initially.

Big Performance and Small Defaults = Big Opportunity

During the recent recession, self-storage proved to be one of the most resilient real estate sectors; throughout this period, self-storage outperformed the core commercial property types, including multifamily, by a significant margin. Impressively, over the past three quarters, the self-storage REITS out-performed all REITS of all commercial property types, as shown in graphic below recently published by Sparefoot.

According to TREPP Loan data, self-storage continues to lead all property types in loan performance, having the lowest default rates in all of securitized lending. As evidenced in the graph below, the self-storage delinquency rate for CMBS debt lies at 3.9%, well below the 9.1% average across all real estate asset classes. The default rate of self-storage facilities also lies well below that of multifamily loans (8.7%), long considered the safest and most recession-resistant investment.

Self-storage provides industry-leading returns while limiting downsize risk, and, due to this, the industry is naturally attracting institutional capital. This capital typically flows to large operating partners who have the sophisticated infrastructure, systems, and capabilities to invest effectively and generate safe returns. As previously stated, this creates a strong environment for consolidation, whereby larger players are acquiring facilities from smaller operators.

Access to Debt and Equity Capital

With respect to financing, size matters. Generally speaking, larger institutions have an increased number of options compared to smaller ones.

Capital markets lenders gear their programs to mainstream properties such as retail, office, industrial, and multifamily apartments. It is not uncommon for these properties to have values that exceed $10M, allowing the lender to impose restrictions on minimum transaction size to support lending goal efficiency. These restrictions require a portfolio of self-storage properties under common ownership in order to qualify. As a result, larger operators with larger portfolios have more access to capital than smaller operators.

There are various types of lenders for the self-storage industry. Commercial mortgage-backed security (CMBS) lenders offer long-term fixed rates up to 10 years on a non-recourse basis at attractive interest rates. These loans are best suited for stabilized, class-B and better properties in major metropolitan areas. Additional restrictions may limit their attractiveness and accessibility for smaller owner operators. The bulk of lenders prefer loans greater than $5 million, which limits competition for smaller loans. Lenders today enforce somewhat rigid liquidity and net worth requirements relative to the loan amount, creating additional hurdles. Perhaps the most significant obstacle, however, relates to transaction costs. Significant upfront good-faith deposits and fairly high transaction costs can make these loans less attractive to smaller buyers.

Another type of lender, insurance-company lenders, specialize in long-term, fixed-rate loans to high-quality facilities in major metropolitan areas. The interest rates they offer are generally among the lowest available, and their overall terms are among the most favorable. Most insurance companies, however, have extremely rigid guidelines and restrictions regarding collateral quality, loan size, eligible property types, and core markets. Only a handful of insurance companies will lend less than $5 million, and many have minimum loan sizes of $10 million and up. Insurance company programs generally favor stabilized properties with strong cash flow and significant sponsorship; borrowers need to have significant net worth and a successful track record in order to borrow. This creates further hurdles for smaller self-storage operators.

Strong Balance Sheets

The largest operators, publically traded REITs, benefit from access to almost limitless capital. These companies generally raise debt by floating bonds with rates today in the 4-6% range, collateralized at the corporate level rather than by the property itself. Large operators generally have the ability to access equity from existing cash reserves or with new stock issuance, thereby allowing them to purchase portfolios of assets for cash and then source any requested debt post-acquisition. As a result, large operators tend to be more nimble because they have the ability to seize opportunities very quickly, especially in regards to distressed real estate. This makes them very attractive buyers given they are able to avoid any finance-related transaction contingencies.

Conversely, smaller operators often have limited access to equity and must secure property-specific debt in new property acquisition. There is less certainty that smaller operators will secure debt at the leverage point necessary to acquire a new property, creating finance risk and other hurdles in trying to raise the necessary capital to acquire new properties.

To compound matters, the cost of capital is typically cheaper for larger operators, given they are perceived as less of a credit risk for lenders. Backed by large cash reserves and easy access to capital, lenders may feel they are more likely to avoid default with larger operators. When large operating partners form joint venture partnerships with institutional equity investors, for example, they typically choose to access the debt markets to leverage their return on investment. In these situations the strength of combined sponsorship typically dictates credit risk spreads of approximately 50-100 bps less than those imposed on smaller operators. Generally speaking, larger operators benefit from credit risk spread advantages due to their balance sheets and sophistication.

As a direct result of their access to more efficient capital, larger operators are often able to outbid smaller competitors on property acquisition. A capitalization rate ("cap rate") can be calculated by a weighted average cost of capital method. By corollary, if debt is inherently less costly for larger operators, they can value a facility at a lower cap rate and thus a higher value, outbidding smaller competitors. Historically, there has been an approximate 300 bps spread between cost of debt and cap rate. This means that an operator whose debt costs 4.5% can purchase at a 7.5% cap rate and maintain a healthy spread, whereas a smaller operator would theoretically need to value that same cash flow at an 8.5% cap rate based on available debt at 5.5%.

The one exception to this rule comes in the form of SBA financing. This niche financing option is intended solely for owner-operators with modest balance sheets, and there are maximum net worth and liquidity limits that preclude many high net worth borrowers. Backed by an implied government guarantee, these loans can reach as high as 90% loan to value. With more use of cheap debt and less equity, the cost of capital decreases, helping to level the playing field for smaller operators.

Sophisticated Management & Call Centers

Larger operators have extremely sophisticated technology platforms, allowing them to run highly efficient, competitive facilities that often out-market and outperform their competition, especially in internet marketing. They spend large amounts of money on internet advertising and perform Search Engine Optimization (SEO) to raise their profiles and drive tremendous traffic to their websites. They also have dedicated call centers with highly trained sales personnel that are experts at lead conversion. Increasingly they are creating mobile applications that allow customers to locate and purchase a unit on their handheld mobile device, and these apps can even track a customer's exact location to price their units accordingly. With more people using the internet and mobile devices to make buying decisions, these advanced technologies are becoming industry standards that can seem overwhelming to a smaller operator.

Additionally, large operators can gather and analyze data on their existing customers in order to maximize revenue management. These sophisticated techniques allow them to raise rates on existing customers such that move-outs due to rate increases are minimal and more than offset by increased revenue. They also collect data from new customers to directly target specific demographics within a population. It is hard to imagine how a small-scale operator can access similar data, institute these sophisticated revenue management tactics, and perform these advanced marketing strategies.

Good things come in small packages

Given the above, it is clear that smaller self-storage operators face tough competition. However, these operators can take advantage of their size in many unique ways. Many small operators are involved in the daily operation of their facilities, allowing them to control expenses, stay on top of maintenance, create relationships with tenants, and deeply understand rental demand and pricing within their sub-markets. This hands-on approach works especially well in secondary or tertiary markets, as opposed to the major markets where small operators can be overwhelmed.

Leveling the Playing Field: Creating Scale Economies

Without question the large operators have the benefit of embedded economies of scale to control costs. To compete with this, smaller operators can join buyer co-ops to help lower expenses; they can save on insurance, credit card fees software, supplies, websites, advertising, and more.

One recent trend in the industry is the emergence of buying groups, such as the Storage Business Owners Alliance (SBOA), to represent the needs of owners and provide a forum for members to share best practices, reduce expenses, improve services, and increase revenue. Buying groups can accomplish what individual companies cannot by using the power of a group to negotiate best prices. Buying groups provide the resources to effectively cut costs and add to the profitability of participating operators by creating economies of scale.

The buying group model is ideal for owners of one or two facilities; however, it can be just as beneficial for larger owners. An owner of 45 facilities has more buying power than a one-off operator but will still not have the same economies as a group with 2,000 facilities. As such, there may still be a pricing advantage to joining a large buying group, as evidenced by the fact that at least one REIT participates in one.


Aggregator websites can help smaller operators who may be lacking a presence better compete on the internet. Self-storage aggregators specialize in achieving high search engine rankings, thereby generating customers for their clients. These sites are expressly created to help people find self-storage facilities in their area and are searchable by city, state, and zip code. In many cases customers can even reserve a unit online. The Sparefoot website (, for example, allows visitors to search by zip code and comparison shop for units. Storage owners pay a nominal monthly fee and pay when units are purchased through the website. Through the site, owners can attract customers with unique promotions, edit and update marketing campaigns in real time, and track their rate of success. The Sparefoot platform integrates with most major management software, updating inventory and pricing in real time. Information about unique viewers, conversion rates, and inquiries are tracked so that marketing can be tailored and personalized. By providing access to internet tools such as this, aggregators enable smaller operators to compete with larger ones in terms of marketing.

Third-Party Management

Increasingly, many small operators in larger markets are choosing to use those operators as third-party managers-the "if you can't beat 'em, join 'em" model. Many of the REITs and other large operators offer robust third-party management platforms, charging 5-6% of the effective gross revenue generated by the facility on a monthly basis. Although this may seem like a significant expense for small operators, these third-party managers have the ability to increase revenue and add significant value. Third-party management provides operators with access to the embedded benefits of the large operators, including their scale economies, advertising, and sophisticated revenue management platforms. As part of the larger operator's website, smaller operations benefit from their online marketing strategies and SEO tactics. They also benefit in regards to back office, repair, and maintenance expenses.

Perhaps the biggest benefit of this structure, however, is the creation of an embedded exit option for owners considering selling their facility at some point in the future. Many large operators in the third-party management business, such as the REITs, are natural buyers, and REIT buyers specifically offer unique tax advantages in the form of UPREIT shares; under this structure sellers essentially receive shares of stock equivalent to the purchase price and therefore defer any initial tax liabilities associated with the sale of the facility.

The trend in REIT third-party management is a statement that the big want to grow. As mentioned, third-party managers are natural buyers, and these operators are essentially creating a natural acquisition pipeline for themselves, allowing for future growth. In continuing to grow, the REITs further take advantage of their economies of scale, making them more efficient and competitive.


The self-storage industry has a bright future ahead. It has proven its resiliency during these tough economic times, and there is hope for growth, both internally through rental rates and externally through the construction of new facilities. It is important for smaller owners to appreciate the challenges they face when competing against larger owners. Given their access to cheap capital, sophisticated management techniques, and economies of scale, these larger operators are able to pay more as they continue to consolidate and acquire additional properties. But by being aware of the challenges, smaller owners can make strategic choices in order to flourish in this growing market.

Mini-Storage Messenger September 2012

This article has been reprinted with permission from Mini-Storage Messenger.

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