It is fair to say that very few things have been stable, consistent, and promising in the past three years for the commercial real estate industry. The market has absorbed disruption after disruption with current rate volatility impacting proformas and debt service coverage across the board. Yet one asset class has continued rising to become one of the top performers. Self storage has enjoyed a surge in performance and relevancy as various events have unfolded to fuel demand in the sector post-pandemic.
The question is, will these conditions persist? Self storage is a seasonal business that has traditionally seen its peak months in spring and summer, with a dip in fall and winter. This past winter we saw a return to more traditional cyclicality with a slight cooling of the unabated red-hot performance of the past couple years. Are we returning to a more normalized cycle for the asset class or have broader economic concerns shifted the landscape? How this summer trends will be crucial.
The tone also seems to be different location to location as some markets are dealing with recent supply shocks, and are seeing resulting impediments to initial stabilization. But there generally seems to be healthy long-term supply-demand characteristics. Most of these overbuilt markets are in the path of population growth (which should put these locations on a path toward success), but those that aren’t might face challenges beyond the short-term. Because of its strong performance, the sector has seen an influx of investment capital (both equity and debt), with billions of dollars waiting to be deployed. Sponsor allocations continue to be set aside for a variety of business plans, including core acquisitions, value-add, and new developments. As the industry navigates the post-pandemic landscape, monitoring seasonal trends and assessing viable financing options in today’s elevated interest rate environment will be crucial for sponsors seeking to deploy capital into self-storage opportunities.
If the cycle performs this summer as expected, we should see a strong appetite for self storage investment later this year. Most of these opportunities will require financing in a market where many traditional sources of capital have exited or severely curtailed their programs, especially as the banking turmoil continues to unfold. The shifts we have seen in capital availability will change how many investors do business. Many owners who have been reliant on one or two “relationship” banks in the past 10-plus years are now faced with a world of unknowns. Challenged banks are being named regularly, securitized lending is very expensive compared to the past, and other options can be uncharted territory.
A stabilizing force
However, life insurance companies have seen a boom in storage lending in the past decade and remain an avenue of stability in today’s volatile markets. The benefits go beyond capital availability. Life companies lock interest rate and loan economics at the time of application, provide certainty of close, and can offer the best rates available in the current cycle.
For life companies, this is a moment in time where they can rise above other traditional self storage lenders, as banks retreat from the market and CMBS continues to price much higher than historic norms. Life companies have long been considered moderate leverage lenders, but in today’s rate environment, where constrained debt service coverage ratios act as a leverage equalizer, they are able to meet proceeds offered by banks and CMBS lenders but at much better rates (and executions). While capital accessibility is challenged by banks seizing up and widely priced securitized lending, life company allocations to commercial lending remain robust, with no signs of slowing or stopping.
What’s important to note is that in the contemporary era for self storage, life companies can offer loan structures that serve as a hybrid bridge and permanent loan. Their education in and exposure to self storage over the past decade has allowed many of them to underwrite extended lease up and stabilization periods into permanent loan structures. These structured permanent loan products range from 5- to 7- to 10-year terms, and are vehicles that Gantry helped innovate with many insurance companies. Life company lenders can accommodate the years needed to stabilize an asset both physically and economically, then the tail carries the loan through the remaining term. These structures remove the need for bridge positions, removing refinance risk at stabilization with one fixed rate-vehicle that can set the stage for an asset’s long-term success. For anyone looking to execute on a financing in 2023, life insurance companies should be heavily considered.