Market Sustainability and How to be a Flexible Investor

Today, we're going to talk about a plethora of important topics to help you better understand how to effectively invest in the real-estate market.  As we discuss these topics, an important thing to remember is that we're looking at it all from the perspective of self-storage investing, but the principles are so important that you can also adapt them to the larger real-estate investment industry as well. Let's jump right into it by first taking a look at the market itself.

Market Sustainability

The vast majority of markets in the United States cannot sustain high rental rates. According to the Self-Storage Almanac, the average cost per square foot to build a self-storage unit is $95.43. However, most markets in the United States cannot sustain rates above $90 per square foot. This means that developers must be careful when building new units and ensure that the rental rates can sustain the construction costs.

Understanding Rates and Building Front Runway

The self-storage industry has been a booming business for the past few years. However, with the rise and fall of rates, it has become challenging for many developers to build and sustain their storage facilities. In this article, we'll dive deep into the industry and understand how rates and building front runways affect the market.

Updraft in Rates for Three Straight Years

For three straight years, rates for self-storage facilities have been rising at a double-digit rate. This updraft in rates has resulted in prices going up, and people were still building despite the high costs. However, as rates rose so fast, nobody cared about the prices. But what happens when rates start to drop?

40% Drop-in Rates in Some Markets

In some markets, rates have dropped by 40%. This has caused problems for developers who were expecting 94% occupancy with 40% higher rates. To fill up their storage facilities, developers had to cut their rates by 60%, resulting in a cratering effect on the market. With multiple developers doing the same, rates went from 40% down to 50%, causing even more problems.

The Delta Between Rents and the Cost to Build

Before COVID-19, the delta between rents and the cost to build was so big that it was irrelevant. However, that is not true today. The vast majority of markets in the United States cannot sustain $90+ a square foot to build, and that just doesn't work. Developers have to be careful in today's market as rates and costs have to be balanced.

If you're developing drive-up and gravel facilities, rates can be pushed down. However, usually, in those markets, rates are already down. At some point, rates won't justify new building, and that's where developers have to be careful. 

Understanding Rates, Connections to Building Front Runway

Developers have to look at the market to understand rates, connections to building front runway, and how the market is changing. Major markets like Oklahoma City have been struggling for years as rates couldn't justify even when costs were a fraction. Even when developers could build at 30% less or 40% less cost, it didn't even matter.

Developers in the self-storage industry have to be careful in today's market. They have to understand the rates, connections to building the front runway, and how the market is changing. Building a self-storage facility requires careful planning and understanding of the market, and with the right approach, developers can still succeed.

The Importance of Market Analysis in Self-Storage Development

I understand the importance of taking into account multiple factors before investing in a development project. It's not just about finding a good location, it's also about considering the cost to build and the rates that can be charged once the development is completed. Unfortunately, many people in the real estate industry tend to assume that rates will always go up, which is not how markets work.

The danger of fluctuating rates

One of the dangers of assuming that rates will always go up is that it can lead to unrealistic expectations for a project's profitability. For instance, a developer might buy land in a market where rates are $280 per unit, but they might plan on charging $350 per unit once the development is completed. If rates don't actually increase as much as they were expecting, the developer might end up making significantly less money than they had hoped for.

Avoiding risky markets

In order to avoid these kinds of risks, it's important to be aware of when markets are pricing in rates abnormally and not sustainably. This is something that I personally experienced when I advised people not to build in Meridian for two years. Even though some people thought I was being overly cautious, I knew that the market was pricing in rates unsustainably and that it wasn't a good time to invest in that area.

The importance of looking ahead

When investing in a development project, it's not just about looking at the current state of the market. It's also about looking ahead and considering how the market might change in the coming years. For instance, even though I believe that the market in which I have three or four facilities is one of the best markets I've ever seen, I wouldn't invest in it again right now because I know that the market is already saturated. In a few years, however, the population might grow significantly, and disposable incomes might increase, making it a much more attractive market.

I know that investing in a development project requires careful consideration of multiple factors, including cost, rates, and market trends. By keeping a close eye on the market and being aware of the risks of assuming that rates will always go up, it's possible to make smart investments that will pay off in the long run.

Assessing the Risk in Good Self-Storage Markets

When it comes to real estate investment, identifying markets that are doing well can be easy. But what's not always easy is identifying the risks associated with these markets, especially when they change so fast. I’ll share some insights on how to evaluate markets that seem good on the surface.

Cost of Development vs. Rates

One of the first things to consider when developing in a market is the cost to build and the rates that can be achieved once the property is built. The mistake many real estate developers make is assuming that rates will always go up, which is not always the case. In fact, rates can fluctuate and planning for unsustainable rates can be dangerous.

The Importance of Market Analysis

When evaluating a market, it's important to do a thorough market analysis. This means taking a closer look at factors such as population growth, disposable incomes, and the presence of businesses in the area. Doing so can help you identify the potential risks associated with a good market, and allow you to make more informed investment decisions.

Understanding the Differences Between Stabilized and Non-Stabilized Properties

One of the biggest risks associated with non-stabilized properties is the fact that they don't have established rent prices. In other words, it takes time to build up rents and achieve stabilization. As a result, investors should not expect to achieve the same rent prices as a more established property.

Investing in real estate is always going to carry some degree of risk. However, by carefully evaluating markets, understanding the risks associated with non-stabilized properties, and doing thorough market analysis, investors can make more informed decisions and minimize their risk. As always, it's important to work with experienced professionals and stay up to date on the latest trends and developments in the industry.

Understanding the Risks in Different Markets

When looking at different markets, it's important to understand the risks associated with each one. For example, in Boise, there were 20 square feet per capita at a dollar a square foot in rent, which is a lot of square footage per person. And since Boise is a boom-and-bust market, occupancy rates there can fluctuate wildly. The same is true for Austin, Texas.

On the other hand, when I looked at markets like Arizona, they had only four-square feet per capita, and the rent was $2 per square foot. And despite growing at the same rate as Boise, there was less risk associated with Arizona because the market wasn't as volatile.

Identifying Markets with Long Runways

Two years ago, I identified a market that had a long runway and low transitory risk - Oklahoma. While they do grow, it's at a slower pace and there aren't the big ebbs and flows that you see in other markets. And since nobody had built there yet, the prices were low.

Building in Core Markets 

When it comes to building storage facilities, it's important to look beyond real estate and consider factors like the rate to build cost and the margin between the two. For example, in Boise, the rate was only a dollar per square foot, and the rate to build cost was so low that even a small decrease in occupancy rates would wipe out any potential profits.

On the other hand, in a market like Arizona where the rate was $2 per square foot and the rate to build cost was much higher, I could lose half of my margin and still be okay. And while some may think that taking unnecessary risks is necessary to achieve equity buildups and impressive growth rates, the truth is that long-term success comes down to good margins and building in core markets with stable demand.

At the end of the day, building storage facilities is not like building apartments or other real estate projects. It requires a different approach and an understanding of the unique risks associated with each market. By identifying markets with long runways and low transitory risk, and by building in core markets with good margins, real estate developers can reduce their risks and increase their chances of long-term success.

The Benefits of Building: Why Development Can Be Safer Than Buying

As a developer, I'm always looking for the best markets to build in, and I've learned that it's crucial to analyze each market individually. By doing this, I can determine what types of storage units will best fit the needs of the local population. For example, when I found Arizona, I went through endless renditions to find the perfect product for that market. This way, I can build a better product that will insulate me in downturns and reduce my risk.

Building vs. Buying: 

Last year, I thought there was more development in buying than there was developing. However, I realized that I could develop at $90 per square foot and had to buy at $250 per square foot in the same market. By developing, I don't believe that there is more risk than acquiring properties. I actually think it's the opposite. Many times, you can develop and have a much safer product than if you went out and bought it. In Arizona, for example, I believe we had more risk by buying than we did by developing.

Analyzing the Market

It's important to understand the market before you start building. When we found Arizona, we went through endless renditions to determine what types of units were needed for that market. This allowed us to build a better product that would meet the specific needs of that population. If you're thinking like this, you can build what the market doesn't have. You can really like it, as opposed to if you just went and bought it, you're getting whatever it is.

Navigating the Risks

So, what can developers do to navigate these risks and ensure their projects are successful? Here are a few strategies to consider:

• Do your due diligence: Before investing in a new development project, be sure to thoroughly research the market conditions in the area. Look at supply and demand trends, rental rates, and occupancy rates to get a sense of the local landscape.
• Plan for contingencies: With so many unpredictable factors at play, it's important to build contingencies into your budget and timeline. Assume that costs may increase or timelines may be delayed, and plan accordingly.
• Focus on quality: With rising costs, it can be tempting to cut corners to save money. But in the long run, it's better to focus on building a high-quality facility that will attract and retain customers. This may mean investing in better materials or amenities, or hiring more experienced contractors.
• Stay flexible: The self-storage industry is constantly evolving, and developers need to be able to adapt to changing market conditions. Stay nimble and be willing to pivot your strategy if necessary.

Understanding Demand

Understanding demand is the hardest thing to do in storage. However, by analyzing each market individually and building a product that fits the needs of that market, you can reduce your risk and increase your chances of success. Development allows me to build my own success, and I have a very good knowledge of what's being used and what doesn't exist in the market. This allows me to put a plan in place that will help me achieve my goals. 

Development is not as risky as people make it out to be. If you do it right, there's not as much risk as people think. It's important to look at each market individually and determine what types of units will best fit the needs of the local population. By doing this, you can build a better product and reduce your risk.

Conclusion

Understanding market demand and the difference between unit square footage and actual units to people are essential in building and investing in self-storage facilities. By analyzing market demand through factors such as population growth and types of occupancy, investors can make informed decisions and mitigate potential risks. Moreover, considering cultural factors and the specific needs of the community can lead to a more successful storage facility. By taking these factors into account, investors can build storage facilities that not only meet the needs of customers but also provide a stable return on investment.