Secure but not risk-free

Resilience to economic ups and downs is a key attraction of self storage, but this new niche category is vulnerable. Christine Senior reports

One of the most recent additions to the growing list of niche categories is self storage. In the UK and Europe the sub-class is still embryonic.

As evidence of investment opportunities in self storage, real estate managers point to the room for expansion in the self storage sector in the UK compared with the US and Australia.

It is estimated that the US has around 6.9ft2 per capita of self storage space, and Australia 1.2ft2, compared with just 0.33ft2 for the UK while for the rest of Europe it is even less. The US Self Storage Association meanwhile estimates the American self storage industry has been the fastest growing sector of the US commercial real estate industry over the last 30 years, with 51,223 self storage facilities in the US as at the first quarter of 2007.

Some 80% of users of self storage units in the UK are domestic consumers, the rest business users. Some factors that favour expansion of demand in the UK are changing lifestyles. Europeans tend to live in small houses or flats, and compared with 20 or 30 years ago they have accumulated more and more possessions which clutter up spare rooms and garages. It makes sense to free up space at home by storing these somewhere else. This being the case, even if the credit crunch dampens the housing market, it may actually have a favourable impact on self storage: people may decide rather than upgrade to a bigger house they should stay put and instead use self storage facilities to declutter their existing home.

Tim Edghill at JLL points to two factors that favour the self storage sector: a changing attitude among consumers and continuing demand for housing. "One factor is a slow probably inevitable change in the culture toward storage itself," he says. "People are recognising this is a useful adjunct to their home, somewhere to keep things. We have become an increasingly consumer driven materialistic society; we have more chattels. Storage has become more of an issue for all of us.

"On top of that there is the long-term housing demand and long-term nature of housing provision in the UK. We are moving more to unitised living, to flats and to high rise communities, especially in major conurbations, and whether or not we go through a housing dip in the next few years there is a significant long-term demand for new homes. In the longer term you can look at self storage and say that growth prospects are still very strong."

Self storage companies use industrial warehousing, dividing it into smaller units and renting to individual customers at higher rents. But where self storage scores over basic industrial property is through the superior income it can generate through the more effective use of space.

"You see much higher rents on self storage units than you find on conventional warehouses," says Andrew Smith, head of investment strategy and deputy managing director at Goodman Property Investors. "Because the occupier is using space more intensively potentially they can pay higher rents. You get a big rental uplift, and you end up with a more valuable unit as a result. That's a big plus."

As the market matures, returns can be boosted even further by skilful management, according to David Carter, project manager at Babcock & Brown. "In the early days you are probably doing more bulk storage where you are letting say 400ft2 to a business client to store his goods. As self storage gets more mature with occupancy above 85% you can diversify income and use that to drive rents. Say you let 100ft2 units then you can start to move towards 50ft2 units and then charge a higher rate per square foot and let them out to two people rather than one."

Carter maintains that there is still plenty of room for growth in the sector, since self storage has yet to take off in many parts of the UK. There is still a lack of awareness of the industry. "As people become aware of self storage you see them switching to it, because it makes a lot of sense. Advertising is mainly inside the M25 [London orbital motorway]. Outside that area people don't know what self storage is. The UK and Europe have a pent-up demand that is currently dealt with by removal companies - or just having a cluttered house."

Unlike a warehouse property let to one tenant, self storage operators are letting space to a large number of customers, thus mitigating risks for investors. Big name companies with a high profile in the sector, Big Yellow, Safestore, Lock N Store remained on analyst buy recommendations in spite of the credit crunch, says Edghill.

"They are very low risk because even though they don't have any covenant, there are thousands and thousands of tenants in their building. You'd have to have a significant fall-out in the market for that to become a significant business risk," he says.

And in the US, where the self storage sector has more of a track record, investors value it for its ability to weather economic storms. Eric Snyder, principal with Buchanan Storage Capital, highlights the performance characteristics of self storage:

"The historical strength of self storage in both a strong economy and a weak economy is capturing the attention of many institutional investors," he says. "There is a belief by many industry experts that self storage maintains its demand in both good and bad economies as users transition from storing excess inventories and consumer goods to downsizing of housing due to job losses. During the last recession while occupancy rates plummeted on other commercial property types such as office and retail, self storage average national occupancy rates only decreased by about 5-7%."

The value of self storage for an institutional investor, such as a pension fund, is its ability to generate strong cash flows, commented Allison Yager, a principal at Mercer in the US.

"It's a good income producing asset, for the most part with low capital requirements," she says. "You wouldn't have to make a lot of improvement on the buildings themselves, like an apartment where you have to make cosmetic upgrades every few years. It's more akin to the level of capital you would spend on an industrial property."

But there are downsides to consider: the short leases, which can be cancelled on a monthly basis, and lack of credit quality in tenants. Risks may be reduced through the number of tenants taking space, but risk is still there. "They are retail tenants for the most part," says Yager. "You don't have any sort of comfort that the tenant base has the means to pay the rent on an ongoing basis like you do with office or industrial property."

Also because the properties can be built quickly and relatively cheaply competition can spring up in no time to threaten the business: "In a market where there aren't a lot of barriers to entry you could have a new unit built down the street and you could lose all your tenants if your property has become a little obsolete," says Yager.

In the UK there are particular risk factors due to the relative immaturity of the sector. The market is fragmented and the risk of consolidations and overcapacity is always present.

"It's a fragmented market," says Smith. "All operators competing with each other for market share are tending to target the same places - big conurbations. The first operator in a town will start to mop up the market until the second and third operators arrive then that market will become diluted. There is a risk of overcapacity."

Inevitably with self storage it is the skills of the operator that are paramount to the success of the business, rather than the management of the underlying real estate. So it is not a pure real estate investment. Cordea Savills has strong reservations. The company has already considered and rejected one self storage investment proposition in Germany.

"We didn't proceed with the German investment we looked at because to us it just looked like an expensive way of buying real estate," says Andrew Allen, head of research and strategy at Cordea Savills. "If the lease and operator aren't in place you might just have a nasty shed in the back of an industrial estate. That's not to say the operators aren't very good and haven't got very profitable businesses. We are not in a position to take an interest in the operators. That's not what we are about - we're property investors."

In the US the self storage sector is more mature and more recognised as a sub segment of real estate in its own right. Four self storage REITs exist, whose combined value reached $16.1bn at the end of September. Some US property fund managers have started over the last couple of years to include a small allocation to self storage. This might be as part of a core type of fund, or a value added fund or some that are labelled alternative property funds. Investment managers such as Prudential Real Estate Investors and Morgan Stanley already allocate to self storage in their real estate funds.

It is via these commingled funds rather than by allocations to self storage as a real estate segment that US pension funds are gaining exposure. Even so, many US pension funds have yet to take the step into self storage.

Clark McKinley, a spokesman for CalPERS, the US's largest pension fund, said: "We don't have self-storage investments in our real estate programme. However, we're interested in this sector and would be open to investments as opportunities appear. It's certainly a sector to watch and evaluate, which we are doing."

Not surprisingly in Europe it seems that self storage is hardly even at the stage of appearing in the peripheral vision of pension fund investors. And institutions like pension funds, as cautious investors, are likely to adopt a wait-and-see stance before dipping in.

Take Danish pension fund ATP, for example. Self storage is not a likely contender for inclusion in its real estate portfolio. "Self storage is absolutely not a real estate class that we have done anything in so far," says Michael Nielsen, CEO of ATP Real Estate. "It doesn't exist in Denmark as an investment product. I have seen very few examples in Europe and the US where self storage is part of an investment strategy. I don't think it's so relevant."

Whether it can be called a sector or sub sector of real estate, it is too minute to be considered in depth by consultants, and by extension by pension funds themselves. The ultimate decision on whether individual self storage operators merit an investment is most likely to rest with each separate institutions' real estate managers on an opportunistic basis.

"We have seen fund managers expanding the sort of thing they invest in," says Greg Wright, a principal at Mercer in the UK.

"If they have the pie chart of retail, industrial, office and other, the other has gradually been getting bigger. It has brought in hotels and student accommodation, which don't naturally fit in other areas so, in principle, if this [self storage] is an area that hasn't been used that much but offers attractive risk adjusted returns, I don't think we'd have an issue with its forming part of client portfolios," he speculates.

But some institutions are already making small allocations on an opportunistic basis in their real estate portfolios, and that will rise, according to Smith.

"If you are a pension fund you are looking after long-term assets and you do need to be relatively risk averse," he says. "That doesn't mean to say some are not willing to move into more opportunistic investments for a portion of their portfolio. Some pension funds do have holdings in the self storage sector. It will be very fragmented, there isn't much of it and one of the obstacles is whether you can obtain access to that kind of stock. It will always be a niche sector but it will become more significant than it is at the moment."