How Inflation Affects Self Storage Assets

The heat of inflation, currently exceeding 7%, is unmistakable and shows no signs of cooling down. In this article, I'll delve into the correlation between inflation and its effects on self-storage. We'll explore the dynamics within my portfolio, examine market trends, and consider potential outcomes resulting from the significant inflationary pressures in this industry and asset class.

Causes of Inflation

Understanding our current situation involves acknowledging the impact of lockdowns, government intervention, and the substantial infusion of capital into our economy. Typically, during a recession, we experience a contraction with households tightening their belts—this is the norm. However, this time, the government intervened by injecting trillions of dollars into the economy, accompanied by historically low-interest rates. 

Effects on Self-Storage

So, how does this economic landscape affect self-storage, your tenants, and your acquisitions in various markets? The self-storage sector has witnessed a significant surge, as evidenced by the explosive increase in sales prices per square foot, as depicted in the chart.

Currently, approximately 10.5% of the population utilize self-storage, up from 9.5% previously.

The challenge lies in predicting whether this upward trend will persist. Rather than assuming continued rapid growth, we adopt a conservative approach. Our underwriting doesn't rely on the assumption that the exceptional performance of the last three years in self-storage will seamlessly extend into the next three years. Instead, we prefer to analyze normal increases, study historical market behavior, and avoid speculative projections based solely on recent exceptional trends in the self-storage industry.

Money is chasing this asset because of its remarkable resilience over the past 15 years. Unlike many real estate assets that suffered significant setbacks in 2020 and 2008, self-storage weathered both crises successfully. This track record, combined with a surge in investor interest, has led to a substantial influx of capital into the self-storage sector.

The compression of capitalization rates, especially since 2010, has been extraordinary as you can see at the image below.

Self-Storage Prices Skyrocket Due to Inflation Impact

This year, we're witnessing trades at prices that were previously deemed unbelievable. A key factor contributing to this trend is the impact of inflation on replacement costs. As inflation took its toll, the acquisition price for self-storage properties increased. Escalating steel prices, labor costs, and land expenses for development led to a substantial rise in the cost of bringing new inventory to the market.

Facilities are now trading at a staggering $300 per square foot, a stark contrast to the $60 to $80 per square foot range observed just a few years ago. 

This surge in prices has created a perfect storm in the self-storage industry, fueled by insatiable demand from investors seeking to capitalize on the sector's performance in the face of economic challenges. 

As we assess our assets and observe on-the-ground dynamics, a dual trend is apparent. On one hand, costs are escalating, particularly in terms of employment, with a notable increase in labor expenses, especially for managers. However, the unique advantage of self-storage lies in its ability to maintain relatively fixed costs on various fronts.

On the revenue side, significant changes have unfolded. Despite cost pressures, we've been proactively increasing rates, resulting in sustained revenue growth over the past few years. Notably, in the preceding year alone, we encountered a substantial 20 to 40% surge in our street rates, coupled with an 8 to 16 % increase for existing tenants. 

Booming Demand in Self-Storage

Heading into the spring, we anticipate further rate increases due to our limited available space and the unprecedented demand we're currently experiencing. This demand surge is unlike anything we've seen since the onset of the pandemic. Notably, our vacancy rates have decreased, markets have become more constrained, and demand has continued to rise, even with the influx of new supply in recent years as seen on the chart below.

This situation puts us in a favorable position. With the majority of our costs being fixed, the revenue growth resulting from increased rates and reduced vacancy is expanding our profit margin. This positive trend has garnered attention, signaling that the self-storage industry has, thus far, benefited significantly from the combination of low-interest rates and high inflation.

Right now, even though inflation usually leads to higher interest rates, we haven't seen that happening in the self-storage business yet. People are uncertain about how it will play out, but rates for self-storage spaces are still going up fast, and many expect this to continue for the next six months.

Now, about finding deals –  we're still finding good opportunities, mostly from direct negotiations with owners instead of going through the regular market. Sometimes, we're paying a bit more for these deals, but there's still a lot of profit potential. Our focus is not just on hoping the market keeps going up; instead, we look at how valuable a storage space is right from the start. Even if the market doesn't follow the same pattern as the last few years, we're still confident in our approach.

Self-Storage Thrives with Inflation

Self-storage is benefiting significantly from inflation. For existing operators like us, our revenues are going up, and although expenses are increasing, a big part of the costs in self-storage is fixed, giving us good profit margins.

On the flip side, deals are becoming extremely expensive, and there's a high demand from investors. Finding a good deal now requires much more effort. It's crucial to keep an eye on interest rates and how they might impact our customers. Fortunately, in self-storage, there are still many opportunities; it just takes more work to discover them. 

Conclusion

Inflation is having a big impact on the self-storage industry, driving up prices and pushing demand higher. While it's hard to say what the future holds, it's clear that self-storage is a hot asset class right now, and investors are eager to get in on the action. However, operators must be prepared to navigate the challenges of rising costs and increased competition. It will be interesting to see how the market develops in the coming months and years.