Monday Morning Quarterback (02/8/2021)

February 8, 2021

Self-Storage Performance in 2020

Over the past decade, self-storage has done $6-$8.5 billion in “arms-length transactions” a year. At the start of the coronavirus pandemic in March 2020, normal self-storage operations were delayed, as many facilities experienced low customer activity due to shelter-in-place orders. Like many other real estate asset classes, 2Q20 was the worst quarter for self-storage last year. Year-over-year (y/y), same-store (SS) revenue for all five self-storage REITs dived by -1.1% to -3.1%, pulling SS net operating income (NOI) down to a range of -1.2% to -6.8% y/y. In addition to a moratorium on evictions, foreclosures, and late fees, the temporary freeze in rent increases for existing tenants contributed to the steep drop in same-store revenue.

Nonetheless, occupancy experienced a significant boost last year. In 2Q, the self-storage REITs closed the quarter at 91.1% to 94.5%, due in part to move-out limitations and the federal moratorium on evictions. During the back-half of 2020, industry fundamentals improved significantly, and by the end of 3Q, occupancy rate hovered between 91.9% to 95.9%, and revenue rose from -2.7% to +1.2%. 4Q20 earnings will be released between February 22 and February 25. During the earnings calls, investors and owners should comment on 1) new supply risks, 2) changing migration patterns/living preferences, 3) sustainability of the elevated demand environment, and 4) external growth opportunities.

Major Industry Players Could Threaten ‘Mom & Pop’

Last year’s big acquirers have the capacity to do 100% of self-storage transactions in 2021 while only adding a “decimal point” to the companies’ overall portfolio. Between Blackstone, GIC, Cascade, and Elliott, collectively, these four groups could easily acquire ~$10 billion+ in facilities this year. With more acquisitions by institutional players, smaller “Mom & Pop” businesses would begin to lose market share, and supply/demand fundamentals would take over, placing pressure on cap rates.

2021 Self-Storage Outlook

To make 2021 projections, self-storage investors need to begin thinking about how COVID may have affected tenants’ lives and how this effect might shape the industry’s near future. Here are some near-term trends we expect in 2021: First, occupancy should stay close to stabilization levels; people are attached to their stuff and resist disposing of it. Second, personal and small business bankruptcies will likely rise due to the pandemic’s continued economic impact. For self-storage, this impact will propel demand higher as people and businesses seek a place to house their equipment and other goods.

If fundamentals stay strong through 2021, a multi-year out-performance cycle is possible before incoming supply likely ramps up again in 2024-2025. Industry experts expect 2021 self-storage revenue growth guidance to range +2-3%, driven by high occupancy, higher net effective rates, and existing tenant rate increases that have begun rising at a “more normal pace.” Experts also estimate that NOI growth guidance will range +1-3%, aided by lower marketing spend against previous years. Higher tax burdens will likely stay in the mid-single-digit range for the “foreseeable future” as local and state governments try to offset budget deficits, particularly in Chicago and NYC.

Long-term Industry Demand Factors

In 2021 and beyond, some longer-term trends will likely drive self-storage demand higher. Possibly the most significant driver of demand will be the public utilization rate, which currently sits at 8%. There is still plenty of room for the asset class to expand and see greater institutional investment. Furthermore, the growth in population and migration will continue to fuel demand. The top ten states with the largest inbound immigration for 2019 were Idaho, Washington, New Mexico, North Carolina, Tennessee, Arizona, Rhode Island, Washington D.C., Alabama, and Texas.

Low interest rates and volatility in the stock market have attracted new self-storage investors at an increasing rate. Investors are interested in the industry’s steady cash flows and historically high occupancy rates in the search for yield and relative safety. In conjunction with the demand for deals, the inventory of for-sale properties has been incredibly thin. Well-maintained properties in desirable locations will continue to see elevated investor interest this year. In 2021, financing will remain a challenge for most investors but not impossible. Due to a shortage in loan originations and higher criteria for qualified deals, lending practices will stay incredibly selective, and qualification will depend on property quality, location, size, market competition, sponsor credit, and related criteria.

ISM Manufacturing

On Monday, the Institute for Supply Management (ISM) reported that manufacturing growth fell to 58.7% from 60.5% in December, the greatest month of factory activity in over two years. Recent manufacturing data has indicated that this level of growth will not decline anytime soon. Last month, 16 of 18 manufacturing industries expanded. Furthermore, all ten sub-indices improved in January, led by a surge in prices to 82.1%, the most since April 2011. This jump in pricing served as a tailwind for the New Orders Index, which surpassed 60% for the seventh straight month. Even the Employment Index expanded last month, clocking in at 52.6%, the highest level since June 2019.

Still Humming: U.S. Manufacturing softens from multi-year high, while prices paid accelerate

ISM Services

On Wednesday, January’s Services purchasing managers index (PMI) rose 1.1% to 58.7%, the highest level in almost two years. January’s expansion in services activity was led by the New Orders Index, which grew to 61.8%. This improvement bodes well for the 2021 outlook in services. Last month’s Services Employment Index registered at 55.2%, improving by 6.5% from December (48.7%). While most sub-indices expanded in January, the Inventories Index slipped 9% to 49.2%, its fifth consecutive month of “yo-yoing” between expansion and contraction. The decline in inventory was due to higher demand and continuing capacity constraints, reflected in the 61.8% reading of January’s New Orders Index (+3.2% m/m). In addition to capacity issues, slower delivery times have continued to impede inventory growth.

Unexpected Acceleration: Gauge of U.S. services climbs to near two-year high with employment firming

January Unemployment Drops to 6.3%

The American economy lost 2.77 million jobs last month, on par with the loss of employment in January 2020 (-2.79 million). However, on a seasonally adjusted basis (the headline rate), the number of jobs grew by 49,000, resulting in a 40 bps decline in U-3 unemployment to 6.3%. The decrease in the headline, U-3 rate beat the 6.7% median estimate from Bloomberg’s survey of economists; however, the seasonally adjusted number of jobs added grew slower than the survey’s median estimate of +105 thousand. The calculation of U-3 unemployment can explain this seemingly contradictory information. Unlike the U-6 “underemployment” rate, the U-3 rate’s divisor does not include those who have stopped searching for work and those who work part-time due to economic reasons. From December to January, the U-6 rate dropped by 60 bps to 11.1%.

Weakening recovery: U.S. Economy added only 49,000 jobs in January after December revised lower

Due to this variance, the unemployment rate has understated the weakness in the job market. Almost four million workers left the labor force during the last eleven months of 2020 and no longer count in the headline, U-3 unemployment rate. If the workforce’s size held steady at its February 2020 level, the jobless rate would be ~9%. Last month, employment growth in professional and business services (+97 thousand jobs), as well as private and public education (+119 thousand jobs) were offset in part by unemployment growth in leisure and hospitality, health care (-28 thousand jobs), retail (-38 thousand), and transportation and warehousing (-10 thousand) sectors. With the pandemic’s resurgence in the past several months, it was no surprise that leisure and hospitality employment fell lower, losing 61 thousand jobs last month. Since February 2020, leisure and hospitality employment has declined by a total of 3.9 million.

Monthly change in nonfarm payrolls

COVID Update

Last week, once adjusting for the February 4 anomaly (see the note below the COVID deaths chart), both coronavirus cases and casualties fell from the week before. After the first week of January, new COVID cases fell significantly, decelerating on a week-over-week (w/w) basis for the past four weeks. Additionally, the number of cases in January fell on a month-over-month (m/m) basis by 4% – the first monthly decline since September. Unfortunately, COVID deaths remained high. January’s pandemic related casualties rose by nearly 100,000 (+24%) from December. As of February 7, total U.S. COVID cases and related deaths were approximately 27 million and 462 thousand, respectively.

Chart of New Coronavirus Cases Reported per Day

Chart of New Reported Coronavirus Deaths per Day

Inflation for January to be Released February 10

The only major economic event expected next week is Wednesday, when the Consumer Price Index for January will be released. We expect core inflation to rise this year; however, it is unlikely that inflation will run “hot” above 2% for any significant length of time. While the money supply has grown dramatically, money velocity is too slow to result in runaway inflation. It’s much harder for the central bank to encourage inflation versus slowing it down.