The idea of making a fortune in real estate tends to bring about images of fancy, ornate buildings like high-rise office towers or casinos. While these are one way many people have made a fortune in real estate, there are other, less flashy ways to do so.
One of these ways is in self-storage units. Sure, it sounds like a dull business, but one look at a 10-year stock chart for Life Storage (LSI +0.00%), Extra Space Storage (EXR +2.90%) and CubeSmart (CUBE +2.83%) will likely get you wondering how this under-the-radar industry can produce such incredible returns.
If you're serious about making a fortune in real estate, you should consider these three real estate investment trusts (REITs).
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The investor appeal of self-storage real estate
Real estate of any kind can, if managed well, generate incredible returns for investors. But what makes some segments more appealing than others is the degree of difficulty for generating those returns. Self-storage units are, arguably, one of the easier methods to make big gains in real estate.
One reason is that self-storage units tend to retain customers at reasonably predictable rates. According to Extra Space Storage, more than 60% of customers lease space for at least 12 months. This is interesting because, unlike most real estate industries where long-term leases are the norm, most self-storage rental rates are on a month-to-month basis, which allows rents to be raised to market rates.
Another aspect of self-storage that makes it compelling is that operating and development costs are low relative to many other types of real estate. Life Storage, Extra Space Storage, and CubeSmart's net operating income margins -- revenue minus operating costs -- for all of 2020 were 67%, 71%, and 70%, respectively.
Similarly, construction costs on a per-square foot basis for self-storage range from $25 to $75. By comparison, construction costs for a distribution warehouse are somewhere around $215 per square foot. Low-cost construction and even lower-cost operations mean that more revenue flows to the bottom line, which is important because REITs are legally obligated to pay out at least 90% of net income in the form of dividends to their investors.
Factors like these add up, and they have been a major factor in helping all three of these self-storage REITs generate market-beating returns over the past decade.
LSI Total Return Level data by YCharts
The appeal of Life Storage, Extra Space Storage, and CubeSmart
As an industry, self-storage is one where you're likely not going to go wrong making an investment in it. There are no guarantees of gains or market-beating returns, but the chances are pretty high. These three self-storage REITs stand out as particularly good picks for the next decade for a few reasons.
Acquisitive companies in a fragmented industry
According to Extra Space Storage, about 45% of self-storage properties in the U.S. are what would be considered institutional-quality properties that aren't owned by REITs. This gives all three ample room to grow their existing footprints significantly.
But more importantly, all three of these companies have a good track record of making acquisitions that lead to shareholder growth. CubeSmart has executed $2.2 billion in wholly owned and joint venture-funded acquisitions, not including its pending $1.7 billion acquisition of Storage West; Life Storage has made $2.1 billion worth of acquisitions since 2018; and Extra Space Storage's two largest acquisitions alone totaled $3.7 billion.
New operating models to enhance returns
Self-storage is by no means a high-tech industry, but all three companies have been able to greatly enhance their returns by injecting some much-needed property technology into the space. Life Storage, for example, has rolled out self-service, contactless check-ins via a platform and app that allows customers to search available units close by and rent instantaneously. Extra Space Storage has been able to leverage similar tech to boost occupancy of recently acquired facilities from 75% to 95% as of the most recent quarter. These self-service, contactless sale models has also helped to reduce staffing demands at facilities.
In addition to streamlining customer acquisitions, these tech platforms are also allowing self-storage units to dip their toes into e-commerce. Better data tracking at their facilities is allowing these companies to become makeshift last-mile logistics and inventory management nodes for supply chains and transport companies.
Fast-growing, third-party management businesses
As acquisitive as all these companies have been and as cheap as it is to develop self-storage facilities relative to other real estate types, it is still capital-intensive to own and operate facilities. Life Storage, Extra Space Storage, and CubeSmart have all found another way to grow the business that doesn't require those big capital costs: third-party management.
Instead of taking ownership of the property and running it themselves, these REITs also offer to manage the facilities for other owners in exchange for management fees. It's a win-win situation for both because the owner of the facility benefits from better tech platforms that have proven to boost occupancy, and each REIT gets to significantly boost growth without as many capital outlays. There is also the added bonus of being able to test-drive the facilities to see if they are worth acquiring.
And again, this is a fragmented industry, so there are lots of opportunities here. In the past five years, CubeSmart has acquired 186 facilities, but it has been able to sign up 496 facilities for third-party management contracts. Life Storage's third-party management fee income has grown 30% annually since 2018.
A fortune to be made in the self-storage industry
Let's be clear here: Investing in self-storage REITs, or any REITs for that matter, probably isn't going to make you rich overnight. These aren't the kind of businesses that will produce 10x growth over a couple of years. What you do get, though, is steady growth over the long haul that has so far proven to significantly outperform the market. Life Storage, Extra Space Storage, and CubeSmart are the types of investments that, if you hold them for long periods of time, can help build you a fortune that will help you retire comfortably.
