What is the Smart Money Doing?

Today’s top investors are taking advantage of the current marketplace conditions to monetize their assets before this expansion cycle comes to a close. The window to sell is now. The market has already begun to turn and we know that a larger shift is coming due to four main factors.

RISING INTEREST RATE

The Federal Reserve signaled for another interest rate hike before the end of the year and three more in 2018. Right now, it is hard to tell what kind of impact all this could have, but this combined with the unwinding of the Feds balance sheet could affect liquidity in real estate debt markets.  Overall, the rising cost of capital could have negative effects on investor returns.

RECORD NEW CONSTRUCTION

There has been record high construction spending and development over the past several years and there are no signs of it slowing down.  Development deliveries are predicted to peak in late 2018 or early 2019, the majority of which are in the top 25 MSAs. Many of the new projects are going to be third party managed by the best in the business such as Extra Space Storage, CubeSmart Storage, and Life Storage. Even though some MSAs appear to support additional supply, the localized owner will now have to compete with Class A professionally managed properties.

PRESSURE ON OPERATING FUNDAMENTALS

With all the new supply coming online, there will be more competition for existing facilities. This pressure has already begun impacting the REITS and it is only a matter of time until it has an industry wide impact. Overall, REITS have reported a deceleration in occupancy and revenue year over year for both Q1 and Q2 of 2017, and an increase in expenses such as real estate taxes, insurance costs and labor costs. Promos and discounts, used to drive demand, also appear to be up year over year pointing to the balancing act operators need to do in order to keep occupancy high.

END TO HISTORIC CAP RATE COMPRESSION

The current market cycle peaked in the summer of 2016 which means an end to the historically low CAP rates of recent years. While there hasn’t yet been a dramatic spike in CAP rates, the factors mentioned above among others have and will continue to put downward pressure on values. Transaction volume has dropped significantly as the gap between buyer and seller price expectations has grown. This is evident when examining acquisition volume year over year. Total transaction volume through the first 2 quarters of 2016 was approximately $3 billion as compared to the first 2 quarters of 2017 that totaled approximately $1.5 billion. Many buyers have signaled that pricing is too aggressive and that better buying opportunities will present themselves as the market shifts and values decrease. Consider this; assume your property has a net operating income of $500,000 and could trade in last year’s market at a 6.0% CAP rate. A minimal 50 basis point increase on your property will decrease its value by $641,025. You would need to increase your net operating income by almost 9% to make up that difference in value.

While it is hard to pinpoint exactly when a dramatic shift will happen, there is no doubt that the change has begun. Unless your investment plan is to hold your assets for 7-10 years, the window to capitalize on the current cycle is now. Self-storage is still a tremendous asset class to invest in due to the simplicity, historical recession resilience, and high returns. There is still a plethora of new money waiting on the sidelines to get into self-storage especially since the REITS have pulled back. Now is the time to maximize the value for your asset in this current expansion cycle. If you wait until after the market correction, your returns could be significantly impacted.

The “smart money” is preparing for this shift while watching and listening closely. As an investor, it is important to be thinking ahead towards the next stage in the cycle, and begin stockpiling cash to prepare for when prices drop. We are going to see many more reasonably priced assets coming to market as less prepared owners try to get out late in the game.

This article was written for the SkyView Advisors website and was also published on the List Self Storage website.