Self-storage real estate investment trusts (REITs) are low-risk investments in many ways. Most have conservative balance sheets. And self-storage facilities tend to be cheap to build, maintain, and operate.
On the other hand, self-storage properties usually have short lease terms. That makes them sensitive to weak economic conditions and competition.
Are you looking to invest in a REIT? There are some contrasting dynamics to be aware of. Here’s a rundown of how self-storage REITs work, the risks involved, and look at some of the largest self-storage REITs in the market.
What is a self-storage REIT?
A real estate investment trust, or REIT, is a type of company that primarily invests in real estate assets. To be considered a REIT, a company must meet certain requirements, like:
- investing at least three-fourths of its assets in real estate,
- deriving at least three-fourths of its income from its real estate assets, and
- distributing at least 90% of its taxable income to shareholders.
In exchange for meeting these and a few other requirements, REITs enjoy a unique tax treatment. They don’t have to pay any corporate tax, no matter how much income they earn. REIT earnings are only taxed on the individual level after they’re paid out as dividends.
As the name implies, a self-storage REIT owns and operates self-storage facilities. They lease storage space to customers. Leases are typically on a month-to-month basis, but annual leases aren’t unheard of.
From a business perspective, self-storage properties can have excellent risk-reward profiles. These properties have relatively low construction, ongoing maintenance, and operational costs. In fact, leading self-storage REIT Public Storage says it can break even with occupancy just over 30% of its rentable space.
Risks of investing in self-storage REITs
Although self-storage REITs have a favorable cost structure for investors, that doesn’t mean they’re risk-free. There are several potential risk factors self-storage REIT investors should be aware of.
No discussion of REIT risks would be complete without mentioning interest rates. Put simply, rising interest rates have a negative effect on REITs. Especially long-term rates for U.S. Treasury bond. This is true of their stock prices -- not necessarily the underlying business.
As interest rates rise, investors expect more of a “risk premium” from their other income investments. Since price and yield are inversely proportional, higher yields translate to lower stock prices. As you can see from this chart of 10-year Treasury note yields and REIT prices, you’ll see that they almost always move in the opposite direction.
When supply of a particular type of property exceeds the market’s demand, it can cause vacancies to soar. Oversupply can also erode pricing power.
Self-storage properties are cheap to build and barriers to entry are low. So oversupply can become a problem quickly.
In fact, the main reason that self-storage REITs have been one of the real estate sector’s worst performers in recent years is oversupply. It appears that supply and demand are finally starting to balance out again, but this is a lingering concern in the self-storage industry.
Most (but not all) REITs use some degree of borrowed money to finance growth. REITs with higher leverage are more susceptible to recessions and other adverse market conditions.
In other words, REITs with lots of debt may not be able to meet their interest obligations during tough times. They’ll have to cut dividends or sell assets. This is especially important in economically sensitive subsectors of real estate. That category definitely includes self-storage.
Self-storage REITs are economically sensitive, or cyclical, businesses (I’ll discuss this more in the next section). Self-storage units are often a discretionary expense, and they’re generally leased on a month-to-month basis. So it’s easy for tenants to vacate when they need to cut back.
When recessions hit, it’s reasonable to expect self-storage vacancy rates to climb. They tend to climb more than vacancies in less cyclical types of properties, like offices and healthcare.
How do self-storage REITs hold up during recessions and tough economies?
Not all types of commercial properties are in the same business category. There are two things to consider when looking at a REIT. First is cyclicality or economic sensitivity. Second is its lease structure.
When it comes to cyclicality, self-storage REITs are a mixed bag. A self-storage unit is a discretionary expense and vacancy rates tend to spike during tough economic conditions.
But self-storage real estate also comes with one of the most recession-friendly cost structures in the entire real estate industry. Minimal maintenance and operating expenses are good news for investors.
Vacancy rates spike during tough economies because of self-storage lease structures. It’s hard to cut back on an expense you’ve agreed to pay for a long period of time, like a mortgage or car payment.
Unfortunately, self-storage units are generally leased on a month-to-month basis. This makes it easy for tenants to leave on short notice.
The “big five” self-storage REITs
The self-storage industry is quite fragmented. There are only five major publicly traded REITs that specialize in self-storage properties. And they own less than 16% of the approximately 44,000 U.S. self-storage properties between them. The rest of the existing self-storage inventory is owned by smaller companies or independent operators.
With that in mind, here are the five major self-storage REITs, the relative size of each, and their dividend yields:
|Company (Stock Symbol)||Market Capitalization||Dividend Yield||Number of Properties|
|Public Storage (NYSE: PSA)||$217.30||3.7%||2,757 (2,661 self-storage)|
|Extra Space Storage (NYSE: EXR)||$99.87||3.4%||1,647|
|Cube Smart (NYSE: CUBE)||$30.95||4.1%||1,086|
|Life Storage (NYSE: LSI)||$94.15||4.2%||774|
|National Storage Affiliates (NYSE: NSA)||$28.22||4.3%||707|
How to invest in self-storage REITs the right way
REITs are best utilized as long-term investments. There are too many variables that affect REIT prices over short periods of time, and some have little to do with business performance. Prevailing interest rates are a great example.
But over long periods of time, the effects of interest rates and economic cycles tend to balance out. So REITs with solid business models and responsible management tend to do quite well.
I don’t advise investing any money in REITs that you’ll need in the next five years. For example, I’m 37 and plan to hold most of the REIT stocks I own through retirement. I suggest you think about REIT investing in a similar way.
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