107 Insider_June 2019

Up, down, or indifferent?

As uncertainty in the property market continues, where does self storage sit in the cycle? In recent months we have seen oversupply and ‘discounts’ amplified in the press. Is self storage caught in the current tidal wave? Or is it a case of being tarred with the same brush? Let’s explore the detail.

Linda Sharkey is presenting at this year's SSAA Convention in Cairns. Linda is a Certified Practising Valuer, Chartered Valuation Surveyor and leader of the self storage team at Urbis. With 12 years’ experience, she has full geographical coverage in valuations and advisory across Australia and New Zealand. In addition to self storage, Linda is experienced in highest and best use analysis, feasibility testing, value capture and market trend studies.

Through the research that we undertake for two

industry publications on market trends – the Urbis Storage Index (USI) and the Urbis Self Storage Supply Tracker – we monitor average storage fee rates, average occupancy levels and new supply.

AVERAGE STORAGE FEE RATE GROWTH The February 2019 release of the USI identified a slowing trend in average storage fee rate growth in most regions across Australia and New Zealand. The long term (10-year) average storage fee rate growth trend between 2009 and 2017 was 2.71% 1 , incorporating a low of 0.87% in 2015 following a high of 4.15% in 2014. The more recent result for 2018 indicates an increase of 1.78%, following growth of 3.65% in 2016 and 2.71% in 2017. When we examine this pattern year-on-year, it suggests that fee rate growth is in its own two to three-year growth cycle, as demonstrated in the table above.

Assuming fee rate growth trends are in a soft-moderatestrong cycle, the trend would suggest a soft result in 2019 before returning to moderate growth thereafter.

However, predicting future performance based on historic trends assumes market parameters remain consistent. This is not the case when increased supply is introduced.

NEW SUPPLY Preliminary results for the first half of 2019 suggests that there are currently 46 proposed self storage facilities in the pipeline across the monitored regions of Sydney, Melbourne, Brisbane, Perth, Adelaide, Gold Coast and Auckland. There have been at least 10 newly completed facilities in the monitored regions in the past six months, located in Adelaide (1), Auckland (1), Brisbane (3), Gold Coast (3), Perth (1) and Sydney (1).

This follows the completion of 13 facilities in the six months prior – providing a total of 23 additional facilities to the market in the past 12 months. Looking forward in the short term, new supply releases are likely to slow but continue.

OCCUPANCY LEVELS Our research recognises the impact of increased supply on occupancy levels. The most resent USI publication suggests a decline in occupancy (by area) in most measured zones over the past 12 months, with only Brisbane and Auckland demonstrating modest increases in occupancy levels. The remaining zones demonstrated reductions in average occupancy levels of between -0.18% and -3.38%, as detailed in the following table:

Occupancy levels fluctuate month-to-month and year-on-year. We gain a deeper understanding of occupancy performance when we examine average occupancy levels over a longer period. The below table demonstrates the average occupancy levels in the Inner Sydney, Outer Sydney, Inner Brisbane, Outer Brisbane and Auckland zones 2 over the past 10 years, with the red trend line demonstrating the weighted average across the zones.

While every zone has varying results each year, the above graph demonstrates a pattern of falling occupancy levels from peak levels of 2015/2016.

This can be more clearly demonstrated in the below table, where most zones demonstrated average occupancy levels below their 10-year average in the most recent USI release. Only the Inner Melbourne and Auckland zones are tracking ahead of the 10-year average.

Nevertheless, the weighted average 10-year occupancy trend remains relatively consistent.

IMPACT ON VALUE So how do the recent trends of slowing fee rate growth and declining occupancy levels impact on the asset’s value? There are several factors influencing the going concern value of a self storage facility, however, the single most important factor

is revenue, which is largely determined by storage fee rate and occupancy. A fall in either can be subsidised by a greater rise in the other, which is the art of successful management. A downward trend in both fee rate and occupancy poses as a greater risk to the asset’s value.

There is another dimension to revenue lurking in the background which can have an impact on the asset’s value – concessions. Concessions are credits issued to a customer and are generally designed to provide an incentive for customers to sign up to a new storage agreement such as ‘first month free’ or ‘50% off your second month’.

Occupancy reports from management software report the ‘face’ fee rates and revenue being achieved. Concessions are reported separately. When we talk to market storage fee rates, we are talking to the ‘face’ fee rates, without any regard to such concessions. Similarly, when we discuss fee rate growth trends, we are tracking fee rates at ‘face-value’. The danger of reporting market performance on ‘face’ fee rates is that we are failing to reflect the somewhat hidden impact of concessions on net revenue, and in turn, on value.

The widespread use of concessions is a relatively recent trend. Analysing data across a selection of portfolios, the average concession rate in 2017 was 2.17% in Australia and 0.82% in New Zealand. A noticeable increase was apparent in 2018, of 3.46% in Australia and 1.40% in New Zealand. This rise in concessions is posing as a bigger risk to value as it threatens real revenue growth, with the potential for reduced net revenue even with increased fee rates.

CONCLUSION Self storage is not immune to market cycles. Competition is increasing, although new supply which responds to demand continues to be absorbed. Fee rates are growing, albeit at slower rates, and occupancy levels are generally being maintained in terms of their 10-year average.

We continue to see robust purchaser activity and strong interest. This is being generated from traditional operators seeking to expand their portfolio, together with interest from new participants including overseas interest. Increased market activity has brought the benefit of strong capitalisation rate compression in recent years. However, we are not expecting capitalisation rates to compress much further in the current cycle.

We are of the view that value growth in the short term will be largely dependent on actual revenue growth. The most significant challenge to achieving actual revenue growth in real terms, is the rise in concessions.

The impact of the increased use of concessions has largely gone unnoticed in terms of value due to stronger capitalisation rates, although the present and future markets will not be as forgiving. We are now starting to observe instances whereby reduced net revenue has offset the benefit of stronger capitalisation rates.

The real question is, are concessions creating value or are they just a short-term occupancy fix? l

1 Includes the East Coast city and Auckland regions only. The Perth region was introduced into our analysis in mid-2017, however Perth does not form part of our long-term analysis or average fee rate references. 2 Perth has not been included as the USI has only been tracking the Perth Zone since 2017.