Published in Mini Storage Messenger, August 2008 – by John Barry
The Pennsylvania self storage industry is as diverse as our country is as a whole. We have the urban markets of Philadelphia and Pittsburgh and the suburban markets that surround them. South Central markets include Harrisburg, as well as Gettysburg, Carlisle, Lancaster, Reading and York. The Lehigh Valley and Wilkes-Barre/Scranton corridor to the east and finally, rural properties scattered throughout the state. Pennsylvania, like all mid-Atlantic and northeast states, has not been overlooked when it comes to the self storage industry. It is rare that you can drive through a town and not see several self storage facilities or as they call them today, stores.
Quite often new self storage investors or developers will ask us where they should build their new project. They expect a list of towns for them to run off to, buy cheap land, build a project, open the doors and lease up quickly. The Pennsylvania markets have become like most markets across the country − very competitive. It is a longer and tougher process to find an under-supplied market, acquiring a prime location at the right price, getting all the entitlements, and hoping the construction costs stay in the ballpark during the process. More and more a detailed feasibility study is highly recommended as there are markets where competing facilities are stuck at the 50-60% occupancy level. As a rule of thumb, supply is ranging from 3-4 square feet per person in the rural markets to a high of 5-6 square feet per person in suburban areas.
Self storage facility sales have slowed down since the credit crisis began in the financial markets last August. Until then and for the preceding 3 years, the acquisition market was robust. A large national buyer had acquired over 200 stores in a short period of time, pushing prices higher and keeping them there.
August of 2007 brought about a significant change in the markets. The majority of the long term financing for self storage loans was done through collateralized mortgage backed securities (CMBS loans) where banks sold their loans to Wall Street firms who repackaged them into bonds for their investors. The interest rates, term structure, amortization periods, interest only options, and spreads on these loans were incredibly attractive, and the demand for this paper was high. Once the sub-prime crisis erupted, the self storage bonds were painted, unfairly so, with the same brush, and the market shut down.
As a result, loan terms became tighter. While the nominal interest rates are still very attractive, other terms and loan structures are more stringent, which in effect slightly raises the cost of money for buyers. The bottom line to buyers for them to receive the same rate of return on an acquisition as they did before the credit crisis means the price of the facility must adjust downward. The result has been about a 50 basis point increase in cap rates. This increase also applies to trailing 12 month net operating income. Buyers are no longer acquiring properties based upon pro forma numbers.
This good news is that prices are still near all time highs, capital gain rates are still at all time lows, and buyers still have cash and the desire to acquire well located and solid operating facilities.
Financing terms for solid credit or experienced self storage operators are between 5.5% and 6.50%, 20 year amortization periods, and usually recourse loans. First time developers are finding it difficult to get financing right now.
Inventory for sale that is priced correctly and is based upon true 12 month net operating income will find multiple offers. Another market change has been that any leverage in the transaction has shifted toward the buyers and away from the sellers. Many of the national large operators feel that bargains can be had in the second half of the year.
Cap rates on well-run, well-located properties in healthy suburban areas are still between 8% and 8.5%. More affluent or denser areas could still see sites offered in the 7%-8% price range. Rural properties are between 9%-11%.
Occupancy rates across the state are in the 82% range which is down from 83% just 3 years ago. Stabilized properties are considered to be 85% these days which is also down from 88%-90% five years ago. This is due to greater competition and the operators’ desire to raise rents when occupancies exceed 85%. Pennsylvania still encounters an annual occupancy cycle with the winter months dipping down on average 5-7 percentage points.
New construction has slowed dramatically. According to the SSA, actual construction starts across the country fell from 2,954 in 2005 to 1,420 in 2007 or a decrease of 52%. Estimated starts for 2008 are 1,200. We have seen new sites approved for self storage which are secondary land sites or building conversions. These do not draw the same buyer/developer interest. Competition today dictates primary road locations.
Suburban Philadelphia can be defined as the four counties surrounding the city – Delaware, Chester, Montgomery and Bucks. One sale of note included 4 downtown Philadelphia locations which sold for an 8.2% cap rate. Sales of land and approvals have again occurred at good levels between $750,000 and $1,500,000 although again, prime locations are needed these days to entice buyers. Rental rates are holding steady at an average of $11.50 per foot per year for the outer areas, increasing to $16 per foot closer to the city. Feasibility studies for the area are running 50/50 as to a positive or negative recommendation to build, thus developers of new projects should be very cautious not to overbuild a specific area.
Very few properties have sold in the Pittsburgh area, although a 3-property portfolio with a solid operating history is on the market at a 6.25% cap rate. Valuations on properties within the metropolitan market are in the 8.5% cap rate range.
The Pittsburgh rental market has remained healthy with low vacancies and stable rents. There is a great disparity in rental rates between the City and suburb properties as compared to those just outside the metropolitan area. Rates can differ as much as $5/SF/YR. New construction is occurring at a moderate pace with most projects being constructed in infill locations and owners adding onto existing locations.
Central Pennsylvania has been a steady market for self storage over the last several years with development maintaining pace with demand. Existing owners and local developers have built a number of new, larger, facilities in the market as well as expanding their current locations. This area may need a few years to absorb the new supply before further development is warranted. Rental rates range from a low of $6/SF/YR for rural properties to $9/SF/YR for the newer properties with all the amenities.
There have been new facilities opened in the past couple years in Allentown, Bethlehem, and especially in the growing communities to the north. There are also multiple sites for sale with land and approvals which are priced in the $1,500,000 range and rents in the market are in the $11.00 range. The Scranton-Wilkes Barre market has seen smaller more rural facilities change hands and the market is stable, but flat.
The Pennsylvania market is healthy overall and the slowdown in development should be viewed as good news for existing owners. This allows time to raise occupancies and hopefully prices over the next few years. For developers, banks are requiring feasibility studies to ensure the projects they are lending on make sense. There are several examples of projects that were built in poor locations or in markets with little excess demand that are not leasing up according to schedule that serve as reminders that the days of “build it and they will come” are over.
Rental rates continue to move upwards as astute owners pass on the increased costs of operation to their customers. Discounts are utilized typically in lease-up situations only and are of the short term nature.
Although there has been little inventory for sale, sellers are making the adjustment in the market to cap rates based upon real numbers and finding that values are still very high.
With upcoming changes in Congress and in the White House, we expect to see more transaction activity for the balance of the year.