Commercial and industrial market transactions in the post-Haynes Royal Commission era in Australia prior to 2020 primarily saw owners and investors seek long term rental growth and capital appreciation in an ongoing low-inflation/low-interest rate environment. Debt remained available and banks continued to lend. In general terms, retail assets suffered and industrial property shone.
The New Year provided fundamental change and a new-normal. 2020 opened with catastrophic bushfires and progressed into COVID19. We are now in Recession.
Whilst the low inflation and low interest rate environment has been reaffirmed by the Reserve Bank and uncertainty in the residential market bumps along, provisioning for growing numbers of distressed commercial loans is occurring. Negative market implications may become much more pronounced and apparent beyond September 2020 when government support is withdrawn.
Prime industrial assets are the least affected by current economic issues. Quality properties (in terms of location, tenancy strength, scale, investment returns etc) that are least exposed and/or affected by these current issues provide value over the long term ie supply-chain assets, distribution centres etc.
CBD office values face difficult recalibrations with demand and (over) supply brought about by the large uptake of home work/distancing in our new-normal. Low(er) quality assets suffer most in this downturn, including those with high exposure to students, accommodation, retail tenants and discretionary spending, areas that have been directly hit by the pandemic and its multiple uncertainties.
Property deals have generally stalled as owners, occupiers and investors and their funding bodies, whilst remaining engaged with the market, wait to see how the economy travels through the impacts of the Jobseeker/Jobkeeper transition and then beyond 30 September 2020.
The fall in commercial property transaction evidence is obvious generally whereas fall in value is more apparent to particular asset classes. The extent of such value loss is difficult to predict at present and into the immediate future, as there is little sales evidence publically available to directly show changes in yield/capitalisation rates. Current portfolio reporting however is starting to reflect retail devaluations which may well spread to other assets. This highlights the significant valuation uncertainty existing in the current market, a fact recently noted by the API protocol issued to valuers in late March.
A flight to quality is obvious in property markets.
It is within this context that the value of self storage must be seen. Self storage remains one of the few recession-resilient asset classes that continue to be attractive to institutional and industry-aware investors, purchasers and owner operators alike, post-COVID.
We note however the major large-scale casualty in our industry, the failure of the National Storage/Public Storage USA deal in March. This occurred as COVID depressed economy-wide sentiment and spiked the market’s uncertainty regarding risk in such a massive deal.
For the many small owners and operators in the Australasian economy development and transaction opportunities remain for well located sites and well managed facilities with transparent operating systems in our experience. Mature self storage is a cashflow-rich enterprise that offers rental growth over time and improving freehold going concern value to long-term property holders, operators and investors.
Risks to income and occupancy are not the same for self storage as they are in the commercial- industrial context ie they are much reduced. Multiple monthly occupiers in facilities signed-up to unique SSAA agreements generally provide protections to going concerns from any large-scale financial impact. This is one of freehold self storage’s main strengths and distinctions.
The self storage market remains buoyant in our view, with opportunities available to big and small players in urban and provincial Australasia. Capital continues to seek good investments and demand continues for space – albeit tempered by the current economy and COVID.
Facilities that we monitor and owners and operators we regularly speak with have all suffered from upfront issues relating to client financial distress and uncertainty to date. Good managers who know their local markets and clients have steered rent rolls and occupancies with responses including rental reduction periods, rental forebearance, unit relocations and downsizing, innovative marketing campaigns and the like.
The effects on overall rent roll and occupancy numbers have been kept to a minimum in most facilities we speak with, although naturally the short-term effects of the last several months do not as yet show uniform ongoing problems. Tracking management numbers through the remainder of this year will inform longer-term trends for particular facilities and catchments, and apart from any other issue, it is most likely that new supply will slow markedly in next 12–18 months given the impacts of COVID on the markets.
We believe this may be most apparent in mortgage-belt suburbs and outer-urban areas where un/employment, income stress, home-isolation, finance and housing affordability will all combine to pressure discretionary spending.
Increasing self storage supply has affected storage occupancies around the country over the last several years, and affected pricing in particular areas where major facilities compete to obtain and then retain market share in more difficult trading environments.
To date, our experience and advice suggests that falls in gross income have occurred although we note that every facility is unique and circumstances will differ in each store, catchment and region.
In our valuation models we are holding real gross income growth to NIL for storage units in this post-COVID market over the next 12 months (at least) while this uncertainty holds, and impacts of the Recession and a U/W/V shape recovery is debated more widely.
Expenses for greenfield and operating stores are also being reviewed with managements to ensure that recurrent operational costs and any unusual increases in expenses are noted, benchmarked and reported separately.
We must remember that self storage is subject to the ebbs and flows of affordability, the digital world and disruption (especially in inner-urban areas). Self storage is after all, a retail business.
Capitalisation rates (cap rates), which everyone focusses on, have been falling continuously in line with general market movements. Our records suggest that the best mature occupancy, well-performing stores are now generally being negotiated at an equivalent yield/market-based cap rate at or above 6% at the present time.
Most publically-available sales evidence at present however relates to transactions commenced and/or completed in 2019 into early 2020. Deals started and fully completed post-COVID have yet to filter into the wider market but their influence on valuations cannot be ignored. Hence the protocol issued on 27 March 2020 by the API. Even with good industry data built up over many years and access to multiple information sources, valuation is not an easy task in this market.
This recession has not been a property-led downturn, but one where COVID19 has precipitated total change across the entire economy affecting all sectors.
In our view, the next few years will reiterate the strengths of freehold going concern self storage ownership and operations in a fraught economy. Ongoing proactive management, transparent information systems and quality improvements were and are the key to performance.
It will be instructive to see how self storage as an asset class progresses. The current economy is not all doom and gloom as opportunities exist to transact assets in this market by well-informed parties.
The market is mature enough to accommodate the several major purchasers now in the national market. In addition a large number of local, smaller investors and State-based operators speak to us regarding potential innovative property developments, design-and-construct and sale/purchase opportunities available. Alternate funding sources are a growing factor in this area.
Our prediction at this time – dangerous as it is to make one – is that a good self storage facility will retain its freehold going concern capital value over a 10 year discounted cashflow approach, albeit with a potential drop in the short term of up to (say) 3-5% or so where rent roll and/or expenses directly affect pricing, occupancy and recurrent net income/EBITDA.
We also believe, based upon our experience to date, that the current general cap rate range for quality, mature stores will remain at 6-7% or so (excluding outliers), ameliorating the worst effects of COVID19 while appetite remains for the asset class and the amount of capital (both local and international) chasing quality assets continues.
Watch this (self storage) space!