Self-Storage Asset Class Overview

The recent stock market volatility is a good reminder that stock valuations can fluctuate dramatically. It’s also a good

reminder that the stock market will eventually turn negative. It’s this volatility that pushed me to find investments in

alternative asset classes that are not correlated with the stock market. Real estate investments offer relatively low

correlation1 with the stock market while providing diversification to your traditional stock portfolio. This is why I

recommend commercial real estate, including multifamily investments; they offer diversification into tangible assets

that are not directly correlated with the market. Similar to multi-family, I believe self-storage is another asset class that

may offer excellent returns and diversification for myself and my investors.

In this summary, I will provide 5 reasons I believe self-storage is a sound financial investment. But first, I want to provide

some general information on the self-storage market in general. To start, here’s a paragraph taken directly from Yardi

Matrix introduction to their summer 2017 market update:

“During the last decade, self storage investment returns for both private assets and public owners such as REITs

have outpaced most property types. Cash yields in self storage can be strong, and rent growth in recent years

has outpaced most commercial real estate. Fundamental demand drivers are robust, while new supply is

generally modest in most metros. Self-storage properties are enjoying demand from Baby Boomers, who need

extra space as they downsize, particularly as they move for retirement. In addition, younger generations such as

Millennials are increasingly using self storage as an alternative to paying higher rents for more space in an

apartment, since self storage costs per square foot are approximately 20% to 30% lower than apartment rents.” https://www.yardimatrix.com/Media/Downloads/File/269-Summer2017SelfStorageReport

I encourage you to read the Yardi Matrix report for additional market intelligence and insight. Here are some highlights

on the scale of the self-storage market in the U.S. taken from IBISworld and Yardi Matrix:

Annual revenue was estimated at

$36 billion in 2016, and projected to

rise to $37.5 billion in 2017

9.5% of U.S. households rent a self-

storage unit

The top 17 MSAs had rent growth of

6.2% in 2016 and >90% occupancy

There is 5.4 Sq. Ft. per of self-

storage space per person

There are approximately 50,000 self-

storage facilities

There is approximately 1.635 billion

Sq. Ft. of rentable self-storage space

By 2022, 9M Sq.Ft. of additional

supply is required to maintain

current Sq.Ft. per person ratio

Below are Five Reasons to Invest in Self Storage in 2018

1 For more on asset correlation and modern portfolio theory, see the following articles: <link to asset correlation article>; modern portfolio theory

1. Superior Returns

According to the National Association of REIT (Real Estate Investment Trusts) the Self-Storage sector produced an average of 17.43% annual return from 1994-2017. For comparison here are the returns from other REIT sectors over the same time period. For illustration, let’s assume you invested $100,000 in each one of the REITS above in 1994. You also reinvested your annual returns back into the fund at the end of each year, creating a compounded return. What would that investment look like 23 Years later?

Self-Storage outperformed the next best performing asset class by $2,215,650

and outperformed the S&P 500 by $3,494,170!

I encourage you to take a look at the data from NAREIT, there is a tremendous amount of data here. https://www.reit.com/data-research/reit-indexes/annual-index-values-returns

2. Recession Resistance According to the NAREIT the self-storage asset class also outperformed other sectors in the most recent recession. From 2007-2009 the self-storage sector produced an average of -3.80%. For comparison, here are the returns from the other REIT sectors over that same time period: Why was self-storage able to outperform almost every REIT sector during the most recent recession? And why is this sector somewhat insulated to the impact the recession had on other market sectors?

Self-Storage, $4,026,413

Residential, $1,810,763

Industrial, $1,788,859

Healthcare, $1,785,233

Apartments, $1,774,397 Manufactured Homes,

$1,756,477 Office, $1,752,914

Retail, $1,580,085

Mortgage, $1,144,493

S&P 500, $532,243

$0 $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 $3,000,000 $3,500,000 $4,000,000 $4,500,000

2017

$100,000 Invested in 1994 Would be Worth How Much in 2017?

17

.4%

13

.4%

13

.4%

13

.4%

13

.3%

13

.3%

13

.3%

12

.8%

11

.2%

7.5

%

5%

10%

15%

20%

Average Annual Return by REIT Sector vs. S&P 500 from 1994-2017

Source: NAREIT, https://dqydj.com/sp-500-return-calculator

When the economy is good, and disposable income is on the rise, people buy more “stuff” and need a place to store it. In the midst of the recession, when homeowners were losing their homes to foreclosure or downsizing to apartments, they also needed a place to put their stuff. Where do they go? Self-storage units! At the heart of this issue is the fact that Americans have a culture of buying too many things and we can’t seem to get rid of most of it. The demand curve for self-storage seems to be inelastic which helps pull the sector through major downturns. Estimates are that one-third of storage space is filled with items that have been there for over three years.

3. Rent Growth and Positive Net Operating Income

In-place self-storage tenants are generally not price sensitive, as the self-storage rental fee is normally a small portion of a tenant’s monthly disposable income. This allows operators to raise rents as the market demand grows without an impact on occupancy. For example if you are paying $100 a month for your 10x10 storage unit and the rent goes up 6 % to $106 a month most tenants are not price sensitive enough to rent a moving truck and spend a Saturday moving to another storage facility. In addition, there is minimal communication between different tenants at a given facility, which allows for the operator to selectively adjust rental rates for individual tenants. This is one of the main reasons large

self-storage operators are able to, in general, increase rental rates by 5–12% annually. I am working with a self-storage operator who experienced 12% rent growth in their 47 property portfolio across the Southeast. Consistent rent growth of 12% is far too aggressive to include in a pro-forma for a self-storage investment but certainly speaks to the pricing opportunity in this asset class. What does this rent growth allow for? An increase in net operating income drives increased value of the property which drives returns for us as the investor.

4. Tax Benefits of Depreciation

One of the many benefits of real estate investing, including self-storage, is depreciation—the loss in the value of a building over time due to wear and tear, deterioration and age. Depreciation can only be applied to the building, not to land, since land does not wear out over time. Luckily for real estate investors, depreciation reduces one’s reportable net income and, thus, his/her taxes. This depreciation is often passed through to investors via their K-1 statements. Below is a short example of how depreciation works to benefit the investors:

Imagine that you invest $100,000 into a self-storage project which buys you a 10% ownership stake in the project. Everything goes as planned and the project produces an 8% annual return. Typically, the $8,000 gain would be taxable as normal income. However, the IRS allows you to depreciate the property across 39 years on a straight line depreciation schedule. If the property is worth $1,000,000 then you could depreciate $25,641 per year ($1,000,000/39 years). Since you own 10% of the project you can take $2,564 (10% of $25,641) in depreciation. That means your taxable basis would go from $8,000 to $5,436. Essentially you get to take the $2,564 tax free. In some cases, you can decrease your taxable income even further by depreciating over a shorter time period.

-3.8%-6.4%

-18.3%

4.9%

-6.7%

0.5%

-8.2%-12.3%

-19.5%-22.0%-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

Average Annual Return by REIT Sector vs. S&P 500, 2007-2009 Recession

Source: NAREIT, https://dqydj.com/sp-500-return-calculator

5. Fragmented Market Nearly 80% of self-storage properties remain in the hands of small, independent investors. The sector’s solid past performance has begun to capture the attention of large institutional investors. Larger properties in particular are increasingly the subject of interest from institutional buyers, including the larger self-storage companies that run themselves as real estate investment trusts (REITs). The top 6 public companies control approximately 18% of all the facilities with the remaining approximately 82% of the facilities controlled by independent owners. This fragmentation should provide for the opportunity for well capitalized and sophisticated operators to selectively target individual assets and portfolios at attractive cap rates. Consolidation will allow some of these operators to amass attractive portfolios of assets and emerge as large industry players. Once stabilized these portfolios become attractive assets for a REIT to purchase and create an attractive exit for investors. The investment community has taken notice of self-storage as a viable commercial real estate asset class, and the underlying dynamics continue to fuel the sector’s success. With solid recent past performance and upward trending occupancies and rental rates, self-storage represents a tremendous opportunity if purchased at the right price and with the right operator. I am currently performing due diligence on a number of opportunities and look forward to presenting them this year! As always please reach out to me with any questions, I look forward to hearing from you. Kris Benson 518-409-1685 edbens@aol.com