Unlike the US and UK self-storage markets, the Australian self-storage is not institutionalised. Yields and capitalisation rates are higher in Australia. Given the stability of the cash flows, the localised nature of the assets and the high barriers to entry for development, the mispricing of the Australian self-storage market is material offering compelling risk adjusted returns for investors.
Self-storage facilities are purpose built buildings typically located on or near main street frontages in the suburbs in cities and towns. Self-storage facilities typically cover a range of storage facilities differentiated by dimensions and configuration. Other forms of storage include wine and boat storage. The self-storage industry has evolved from the “drive up ranch style” facility to be more characterised by the purpose-built internal unit warehouse product.
Whilst self-storage facilities like office buildings can be somewhat generic, unlike office buildings they are very much localised in nature, particularly in cities. The convenience of the self-storage facilities location is a major decision for customers. The assets are rented on typically short term leases to a range of tenants. Typical self-storage tenants can be categorised as either residential customers or corporate users. Within the residential category, users of self-storage facilities are often labelled either ‘movers’ or ‘hoarders’. The industry has grown steadily due to the lack of feasible substitutes for self-storage services. Corporate users of self-storage facilities range from retailers to varying small businesses for various uses including inventory management, document storage and trade supplies and equipment. A strong thematic driving corporate demand for self-storage facilities from businesses over the past five years has been the growth in eCommerce, with increased demand from online shopping leading to small on-line retailers to increasingly rent storage space to manage inventory within very convenient locations on flexible terms. The flexibility of a storage unit being rented on short lease terms as short as a monthly basis fits with the flexibility in demand for online product as online retailers launch promotions or one off sales programs.
The self-storage sector which began in the US in the 1960’s and in Australia in the 1970’s is now well established as an asset class within the broader commercial real estate spectrum. A key characteristic of self-storage in the US, UK, Europe and Australia is the disaggregated ownership profile. In the US the top 10 self-storage facility owners covering both asset owners and asset managers represent 17.2% of all self-storage facilities with the #1 ranked owner – Public Storage controlling 5.5% of the market with 2,266 facilities. Even if we collate the combined ownership of the top 100 US owners their combined market share stands at 23.4% as measured by rentable space per sq. ft. It is worth noting that more recently US REITs have been actively acquiring smaller operators.
In the UK the self-storage industry has ~37.6m sq. ft. of space across 1,077 assets, an increase of more than 5% on 2014. It is estimated that the total turnover in 2015 was ~£440m across 490 operators. A third of the UK self-storage facilities are held by large operators (operators managing 10 or more sites). London has recorded twice the UK supply per head of population. Despite an increase in supply, occupancy in 2015 increased by ~3% indicating that demand is outstripping supply. There has been little change in the balance between domestic and business use in the past 5 years although this mix will vary by location. Average net rental rates in the UK have steadily been increasing from the previous peak in 2013.
As at March 2015 there were ~2,650 facilities in Europe totalling just over 82m2ft. which is an increase of 9.4% on the number in 2014 and equates to ~230 facilities. Across the broader European market the UK is the largest at 40% of the market followed by France, the Netherlands and Spain. The ownership of self-storage facilities is slightly less concentrated in Europe than in the UK with 27% of the total number of facilities owned by the 10 largest operators compared to a corresponding figure of 33% in the UK. The amount of self-storage space available per person in Europe is very low at 0.02 m2.
On a per capita basis the key US markets (Los Angeles, New York and San Francisco) show between 0.2-0.5m2 per person compared to Australia’s eastern seaboard capital cities averaging 0.1m2 per person. In the UK the ratio is 0.05m2 per person.
The Australian self-storage market totals 1434 facilities generating $1.1bn in annual revenues and employs 3,577 workers. Unlike the US and UK self-storage markets, the Australian self-storage is not institutionalised. Yields and capitalisation rates are higher in Australia and apart from one operator, operational management systems are decades behind the US and UK, with the majority of the industry relying on off-the-street walk-ins as the major customer conversion channel. However, similar to other global self-storage markets, the Australian self-storage sector is highly fragmented. Measured by number of managed facilities the top 3 self-storage operators; National Storage, Storage King and Kennards between them operate ~40% of the self-storage sector. Their market weighting by State will vary although overall National Storage, Storage King and Kennards typically rank within the top quartile. Due to the consolidation trend, establishment numbers have grown slowly over the past five years.
Storage King was launched in 1998 when the company began licensing franchises. Storage King is not a landlord and typically do not own their own facilities. Kennards established its self-storage business in 1973 and has capitalised on profitable assets while divesting certain sites to boost overall storage occupancy and slowed its pace of acquisitions. National Storage is the only listed self-storage operator (NSR.ASX) with a current market capitalisation of $789m and an asset base as at June 2017 of $1.3bn across 116 centres located in Australia and New Zealand.
The industry effectively operates in three tiers with the large branded players, small family owners and medium sized players filling geographic and services niches. Consolidation is expected to increase as large national operators mainly National Storage buyout and/or take on the operational management of the smaller owners unable to offer the same level of services and achieve the synergies of the large players. National Storage is best positioned to consolidate the fragmented market with their “live pricing” revenue management and marketing channel systems, cost of capital advantage and access to the equity capital markets and institutional debt.
The self-storage industry is characterised as having low revenue volatility as many consumers and the majority of businesses store their goods in self-storage facilities for longer than 24 months. Industry profit margins have increased over the past five years, occupancy rates have also risen boosting industry revenue and costs have fallen.
IBIS forecast that in the Australian self-storage market for the five years through to 2021-22, industry revenue is forecast to grow by an annualised 2.7% to $1.2bn due to increasing urbanisation and demand from online retailers. The competitive landscape is expected to remain as barriers to entry limit the amount of future supply in the Australian market.
Given the land constraints in key metropolitan areas on the eastern seaboard, sites suitable for development within attractive catchment areas are difficult to secure at land costs that support development return hurdles (unlevered 15% IRRs). Thus new supply is concentrated in non-urban in-fill sites which has resulted in modest supply levels within Australian cities. This aspect of self-storage plus the challenges for financing new developments have combined to curb excess supply.
With very high city land values, in order to enhance the returns from self-storage some industry players are speculating that new generation self-storage assets will in fact sit above ground floor retail and mezzanine office space in order to improve the financial returns such that self-storage facilities become the dominant use within a mixed use asset.
For residential uses, Australian consumers have limited choices for storage options with the alternative being private storage or hiring a container from a logistics company. These alternatives are often inconvenient and less secure than self-storage industry services. The key drivers for the demand for self-storage assets for residential uses are referred to the four D’s (death, divorce, density and dislocation). Continued densification across metropolitan areas and in particular the surge in apartment projects with demographic shifts as evidenced in households downsizing as “baby boomers” look to crystallise equity from their primary dwelling and move to smaller accommodation. Typically this activity will result in households using self-storage as a part move part hoard function. Other drivers of demand for self-storage include divorce rates, net migration patterns and Local Government Areas with a high proportion of new housing estates with a reduced land size meaning the house footprint is smaller and therefore storage capacity is becoming increasingly limited.
Over the past five years, steady demand from Australian corporates and consumers has supported the self-storage sector with demand forecast to increase over the next five years with the expected increase with the take-up of Ecommerce and city densification increases across metropolitan areas.
As an asset class self-storage has evolved from being classified as a quasi-industrial use to now be akin to a retail offer given their prime street frontages and the industry adopts alternative marketing strategies to the key decision maker in the self-storage decision (50% women) plus adopting alternative self-storage offers such as valet self-storage.
One key characteristic of the self-storage sector is its localised catchment profile that sees potential customers sit within a relatively defined area of ~5-8km from a self-storage location. Given typically in Australia ~65% of self-storage customers are households then the drive time to and from a self-storage facility and its general accessibility is a key factor in the storage choice decision. Furthermore once customers have stored goods with a self-storage operator it is seldom that they will relocate just to benefit from a promotional offer offered by a self-storage competitor given the level of inconvenience to collect and transit goods to a new location.
The ~35% of self-storage users that generally described as corporate users covers a broad spectrum ranging from retailers needing storage for a few months to stock product being sold online to small local businesses using storage to stock ancillary items typically housed in a back office. Corporate users tend to report the longest average stay ranging from 24 months to 36 months. Corporate users are also focused on location, where convenient access is an imperative.
Across the split of residential and corporate users of self-storage, the typical length of stay is 18 months with more churn within the “movers” component of the residential customers and less churn across the corporate clients.
More recently some developers have offered “man caves” ie small industrial units priced at $250K for a 100m2 unit which are popular with trades people wanting off-site storage. Other strata industrial units are being purchased by downsizers looking to park and store hobby cars, boats etc in spaces between 80-100m2. There has been some efforts by Councils to have Caravans and trades vehicles removed from streets in residential areas which could lead to increased demand for storage/parking options off-site. However, this is not a strong thematic due to high urban land values inhibiting self-storage development as the single best site use.
According to Urbis, for the 12 months to December 2016 average storage fees for all East Coast Australia continued to enjoy moderate growth recorded at 2.3%. With the exception of the Brisbane Outer Zone other zones in either the inner or outer zones recorded positive storage fee rate growth with this pattern repeated across the area occupied and monthly revenue indices. Reported occupancy by area across the markets range from Brisbane (83.09%) to the Melbourne Inner zone (90.25%), whilst the Sydney Inner zone reported the highest average storage fee rate at $437.28/m2.
Optimal occupancy for a self-storage asset ranges between 85%-90% in order to have a level of price tension for quoted rates for potential new customers. Due to the low monthly tenant “churn” factor of 5%, passing on existing customer rent increases is less sensitive to occupancy rates which is a fundamental driver of cash flow growth. Typically self-storage operators aim to manage occupancy and rates either measured in m2 or on a monthly basis in order to maximise profitability. The self-storage industry adopts the RevPAR metric (Revenue per available square metre) of storage space leased as a key operating metric. Operators can also earn high revenue margins from the sale of ancillary products including: storage boxes, bubble wrap and insurance.
The facilities also require less maintenance capital expenditure of 2% of revenues compared to other forms of real estate such as office buildings, shopping centres, hotels and residential apartments further improving economic returns.
Storage fee increases combined with occupancy gains are driving revenue growth and operating profit margins leading to higher current net operating income growth compared to other asset types. The attractive revenue profile plus the metropolitan locations of some self-storage assets offers both material revenue growth upside plus potentially a higher and better use opportunity (i.e. residential) as the land underneath the facility becomes increasingly valuable however the existing core cash flow profile offers attractive income returns.
A UK report on the self-storage industry found a clear trend for older age groups to prefer to contact a self-storage centre by visiting it in person rather than via email or online, while younger age groups were more likely to prefer to use email or other online methods. Online marketing has become a material marketing tool adopted by the major self-storage operators not only in the UK and the US but has only been adopted by the operator National Storage in Australia. National Storage adopts innovative live pricing tactics into their offerings drawn largely from sophisticated revenue management systems using interactive pricing software. They also use cloud based interactive marketing tools allowing the self-storage operator to field inquiries in order to increase the probability of converting an inquiry to a sale with this method currently reporting a 35%-40% conversion rate.
The valuation of self-storage assets typically splits gross revenue into self-storage NOI which typically represents ~93% of revenue and a further ~7% linked to merchandise sales (boxes/locks, late fees and insurance). For a mid-sized 550 unit facility advertising costs are typically between $35K-$45K and maintenance capital expenditure of $20k per asset.
A common theme in the US has been the increased competition in geographical areas with high population densities which has also seen well capitalised US Self-Storage REITs pursue development and redevelopment opportunities both on balance sheet and acquisitions of third party fund-through-development increasing market supply. We are not seeing this trend in Australia due to the assets typically valued below replacement cost, the difficulty in obtaining development financing and the higher cost of development.
The development of self-storage assets is unique compared to other commercial real estate assets in that self-storage ground up developments typically take 2 years from completion to achieve 30% occupancy which is considered the cash flow breakeven rate. This creates high barriers to entry limiting supply due to the difficultly in achieving development financing and the economic returns taking longer than other forms of development. This places the well capitalised self-storage landlords non-reliant on development financing and focused on longer term returns at a distinct advantage when funding potential development opportunities.
The following table is an example of a hypothetical feasibility using Australian national average data which serves as a snapshot of development costs compared to a projects Indicative End Value in order to derive a ‘first cut’ of a project’s likely development returns in order to assess whether a development project warrants further detailed analysis. Anecdotal evidence suggest that a preliminary development profit margin of ~10-20% subject to further revisions, is sufficient for a project to be “green lighted” as a potential project. It should be noted that it can take up to four years for stabilized occupancy to be reached and the indicative end value being achieved, however on stabilisation the cash flow returns can be attractive.
The Australian self-storage sector exhibits many of the operational characteristics evidenced in other global self-storage segments namely: disaggregated ownership profile, a customer base split between households and corporates and for National Storage innovative marketing models and revenue management systems.
As the Australian self-storage sector continues to consolidate, bringing the facilities under the ownership and management of the industries technology leader offers strong cost synergies and further revenue growth opportunities.
Unlike the US and the UK, the Australian self-storage sector is yet to be institutionalised. Given the stability of the cash flows, the localised nature of the assets and the high barriers to entry for development, the mispricing of the Australian self-storage market is material offering compelling risk adjusted returns for investors.
This material has been prepared and issued by First Sentier Investors (Australia) IM Ltd (ABN 89 114 194 311, AFSL 289017) (Author). The Author forms part of First Sentier Investors, a global asset management business. First Sentier Investors is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG), a global financial group. A copy of the Financial Services Guide for the Author is available from First Sentier Investors on its website.
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