The best real estate investment in the past decade was found at the opposite end from trophy resorts and office towers, in 5-foot-by-5-foot lockers.
Self-storage companies, which rent units to small businesses and consumers under names such as “Uncle Bob’s Self Storage,” produced the best risk-adjusted return among 10 U.S. real estate investment trust indexes in the past decade, according to the BLOOMBERG RISKLESS RETURN RANKING. They had the highest total return and the third-lowest volatility, for a risk-adjusted gain of 10.6 percent. Owners of offices, hotels and warehouses fared among the worst, hurt by price swings.
Public Storage, CubeSmart, Extra Space Storage Inc. and Sovran Self Storage Inc. attracted investors with low debt ratios and steady cash-flow growth in a decade that saw commercial-property values soar to records along with sales of mortgage-backed bonds to finance a wave of takeovers. The debt-to-assets ratio for Public Storage, the largest in the group, is 22.5 percent, half the average 45 percent for REITs, said Michael Knott, managing director of real estate research firm Green Street Advisors Inc., making the stock less susceptible to large price swings if the economy worsens.
“Public Storage has incredibly low leverage compared to the average REIT,” Knott, whose firm is based in Newport Beach, California, said in an interview. “It’s typically not as volatile.”
The Bloomberg REIT Public/Self-Storage Index topped gauges tracking healthcare REITs and regional mall REITs, which returned a risk-adjusted 8.4 percent and 7.5 percent, respectively, in the 10 years through April. Warehouse REITs, which had the highest volatility and the lowest total return during the period, joined hotels at the bottom, with a risk-adjusted gain of 0.8 percent.
Storage REITs release first-quarter earnings this week. Extra Space Storage said April 30 that first-quarter funds from operations rose 41 percent on higher revenue and cost controls. Sovran is scheduled to release earnings after the market closes today, and the other two companies in the group report tomorrow.
The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period of time, increasing the potential for unexpected losses.
The ranking compares 10 of the 11 property index types within the Bloomberg REIT index. It excludes single-tenant REITs because that index contains just four mostly smaller members whose business of retail leasing is reflected in broader indexes.
Storage REITs had twice the cash-flow growth of REITs in main property types from 2001 to 2011, according to Green Street. Net operating income for storage facilities open at least one year rose an average 3 percent a year during that period, compared with 1.5 percent on average for other REITs.
Companies such as Public Storage of Glendale, California; Salt Lake City-based Extra Space; and CubeSmart, of Wayne, Pennsylvania, rent storage space by the month. The facilities can range from basic 5-foot-by-5-foot (1.5-meter-by-1.5-meter) units to climate-controlled rooms of 25 feet by 25 feet where people can stash goods such as furniture, tools and skis, a salesperson can store product samples, or a small business can keep items as in a mini-warehouse. Demand tends to be driven by life changes, which often entail moving, such as college graduation, job changes, divorce or death.
“If you get married, you don’t necessarily throw your couch away, you don’t necessarily throw away the buffalo head, what have you,” said Clemente Teng, vice president of investor relations for Public Storage. “You put it in storage.”
Public Storage has about 1 million tenants at any given point in time, with the average lease of existing tenants running about 36 months, Teng said. More than half its tenants have rented their units for more than one year, he said.
“People always think, ‘I’ll just house it for a couple of months and then get it all out, but the problem is once you get all your stuff in, the last thing you want to do is spend a Saturday cleaning it out,” Teng said.
Occupancy and rents in the storage business probably will increase over the coming year amid rising demand and virtually no new construction, said Chris Sonne, executive managing director of the self-storage industry group at Cushman & Wakefield Inc. The commercial real estate services firm expects occupancy will increase by 1 to 3 percentage points and rents will rise 3 to 3.5 percent, said Sonne, whose group conducts a quarterly survey of about 7,000 facilities in the 50 largest metropolitan areas.
“Physical occupancy is inching back up so they’re able to really raise rents,” Sonne said.
Median occupancy rose to 81.1 percent in the first quarter from 80 percent a year earlier. The median asking rent for a unit of 10 feet by 10 feet at ground level and not climate-controlled climbed to $90 a month in the first quarter from $88 a year earlier, according to Cushman & Wakefield. Public REITs saw stronger rent growth because their revenue-management tools enable them to increase rents to match demand, said Sonne.
Public Storage, with a market value of $26 billion, accounts for 81 percent of the BBREIT Public/Self Storage Index. Its shares closed at $145.04 yesterday, for a dividend yield of 3 percent. The company operates in 38 states, with California accounting for about 25 percent of revenue.
“It’s not a cheap stock,” Knott said. “It should be an outperformer over a long time period, but over the next three, six or nine months, it’s hard to say it’s going to outperform.”
Two-thirds of the 25 analysts who follow Public Storage have “hold” or “sell” recommendations on the stock, which has returned 58 percent since April 2010, according to data compiled by Bloomberg.
Storage wasn’t always so attractive to investors. In the five years through 2006, when the Bloomberg REIT index more than doubled, regional malls and shopping centers topped the ranking. Storage, while second by total return in that period, fell to third when adjusted for risk, because it had the second-highest volatility, after hotels.
Those price swings coincided with a period where the supply of storage units increased in the U.S. New construction of facilities rose by more than half in the 2000s, with the fastest growth in the beginning and middle of the decade. The U.S. had an estimated 50,048 self-storage facilities last year, up from 29,955 in 1999, according to the Self-Storage Almanac, published by Phoenix-based MiniCo Insurance Agency LLC, which provides insurance and publications for the industry. Storage facilities also got larger, growing to an average of 566 units each in 2011, from an average 243 units in 2000, according to the Self-Storage Almanac.
“During 2001 to 2007, there was a great amount of new supply built because of low barriers to entry and cheap financing,” said Teng of Public Storage. “All that has virtually come to a halt.”
The relatively low capital needs of the storage business became more attractive after the financial crisis, as investors shunned companies with large debt burdens. Storage REITs topped the riskless return ranking since the end of 2009, with the second-lowest volatility and the second-highest total return. Regional malls, No. 2 over that period, had the best total return and the third-highest volatility.
Storage units are relatively cheap to build and “when we re-rent a space, all we have to do is sweep it out,” said Teng. “We don’t have to change the carpeting, paint the walls” or otherwise make improvements to get a new tenant.
High leverage remains a concern for some hotel REITs, which have trailed in returns because recreational travel hasn’t fully rebounded from the slump caused by the recession in 2008 and 2009. Hotel operators tend to see bigger swings in net operating income than other REITs, reflecting their lower operating margins, according to Green Street.
Hotel REITs returned just 0.8 percent over the past 10 years when adjusting for risk. They had the second-highest volatility and the second-lowest return. Office REITs, whose assets include well-known “trophy” properties such as the General Motors Building in Manhattan and Embarcadero Center in San Francisco, had the fourth-worst risk-adjusted return in the period.
Increased usage of Internet marketing has helped storage REITs attract more customers from smaller operators during the sluggish economic recovery, said John Murphy, a vice president at Cohen & Steers Inc., a New York-based investor in real estate shares that manages almost $45 billion. The storage business is fragmented, with the publicly traded REITs accounting for just 10 percent of the U.S. market, he said.
“They’re able to steal market share in a time like today, when demand is growing but at a slow pace,” said Murphy. “With revenue management, they know which facilities they can increase rents on” week by week.
The geographic diversification and large base of tenants gives the publicly traded storage REITs some protection from economic swings, offsetting the short-term nature of storage leases, said Murphy.
Sovran, which operates under the Uncle Bob’s Self Storage name, has been reducing concessions, or landlord incentives, as the economy came out of recession starting in 2009, said Diane Piegza, a spokeswoman for Sovran Self Storage, based in the Buffalo, New York, suburb of Williamsville. During the recession, Sovran offered as much as six weeks free rent and ran a “name-your-price” promotion to attract renters.
“We’re not recession-proof by any means but we’re a little more resistant than other types of real estate,” Piegza said.