Self storage is a capital intensive and location sensitive business. The globally preferred modus operandi is to acquire and own the real estate that the business occupies. This has proven to be the successful and enduring MO for a number of reasons.
Having debated this idea for many years with people who firmly believe leasing storage premises is the ‘new way’ or superior to the classical self storage investment strategy, I remain amused that it persists. It is apparent my arguments are not convincing enough.
The temptation for a self storage operator to lease a self storage property often come with the arguments that:
a) The accountants say a business shouldn’t have such a ‘lazy balance sheet’ holding so much capital in real estate;
b) There is a scarcity of property to be acquired, so leasing is the only way to grow; or
c) The operator lacks the capital to acquire so leasing helps fund the real estate.
In my observations of the self storage industry in more than 2 decades, leasing self storage property has almost always accompanied an impatience of the operator who wishes to grow quickly. These ambitious players hope to assert themselves in the industry quickly.
In the 1990’s, Global Self Storage entered the market and through leasing expanded to 17 locations in only a few years before collapsing.
Other small players have entered on a leasehold basis but haven’t been able to really move ahead.
In 2003, APN created a retail investment product to enable National Storage to sell and lease-back its properties. In a later twist National later re-acquired many of those same assets to make them again a more classical self storage owner-operator, but retaining and operating on a leasehold basis in other circumstances.
The largest and most successful self storage operators in the world own their real estate.
In Asia, securing freehold is very difficult and expensive. Leasing for self storage operators is common, but remains riddled with problems. Leases are short (3 years is typical in Hong Kong) and land owners are keen to ensure their returns are optimised. This commonly forces self storage operators to close or relocate.
Long leases are common in the UK, and the law provides for a somewhat sympathetic rent review and lease renewal. However, major storage operators prefer to acquire freehold.
There are a number of flaws with leasing self storage premises:
1) Risk of forced relocation – Australian landlords typically only offer short term leases. A
landlord committing for longer than 10 or 15 years is unusual. (In Hong Kong, getting a lease longer than 3 years is unusual). This means the substantial capital investment to fit out must be written off in the lease term. The business should also prepare to start up again in a new location when the lease expires, along with the requisite capital investment and rent-up.
2) Risk of an unfavourable market rent review – Leases will re-set the rental to market every few years. A significant market based rental increase may not match the income position of the self storage business at that time, and possibly causing operating losses. This may force relocation and re-starting the business. Problematically, an alternative location may not be available in the area.
In addition, self storage customers do not like being moved. The practical challenge of undertaking the moving of 500, 600 or more of people’s personal effects is not to be underestimated. It takes many months and comes at quite a cost while also losing a significant proportion of the customers.
All this means, the business may have to choose to simply close down, or absorb losses until the income eventually recovers.
3) Leasing constrains capital investment, upgrades and improvements – as the lease expiry approaches, the storage operator will resist undertaking the necessary upgrades and enhancements to keep the business relevant and competitive.Expanding, upgrading and basic maintenance will be deferred until new lease certainty is reached. The tiredness and deteriorating condition can be observed in many leasehold self storage businesses.
In addition, there is a constant wave of up-zoning. Governments around the world are increasing density and changing the zoning uses to enable more productivity from existing real estate. Self storage operators need to keep up and increase their density. If an operator leases the property, the owner will eventually want to crystallise this value.
There is no escaping that self storage is capital intensive and location sensitive. Acquiring and owning the real estate addresses the property cost, giving the operator fixed expenditure for the property it occupies. Importantly also, it enables the flexibility to adjust the service, scale and product offer at any time. Enduring successful self storage businesses own their real estate.