Examining Interest Rate Hike Impacts on Self Storage
Self-storage developers and buyers might have to brace for volatile market conditions, but optimism prevails in the industry.
Image by Frank Busch from Unsplash.
There was a cloud of uncertainty surrounding the self-storage industry at the onset of the pandemic; however, as the crisis compelled people to implement lifestyle changes, the sector began to benefit from heightened demand and became a favorite of many investors.
Strong fundamentals, paired with low interest rates, led to an elevated level of institutional capital flowing into the self-storage sector, putting downward pressure on cap rates. Investors such as Blackstone and KKR started to expand their self-storage portfolios across key and growing markets. Last year, Yardi Matrix recorded more than $15 billion in storage deals, Multi-Housing News reported, more than double the investment amount registered in 2020.
Thanks to heightened investor interest, the storage sector has emerged as a lender comfort zone, along with industrial and multifamily products. Banks, life insurance companies, CMBS lenders, and bridge lenders have all become keen on the sector. Construction financing picked up after a stale 2020 as demand for storage persisted and fears of overbuilding subsided.
Fed Rate Hikes Hit Self Storage
Confidence in the sector remained healthy at the beginning of 2022, despite the risks posed by Russia’s war in Ukraine and high inflation. However, as the Federal Reserve pushed rates upward starting in March to get inflation under control, the strong investment and financing trends seen last year are expected to soften in the upcoming quarters.
Within two weeks of the first hike in March, “the best terms for long-term, fixed-rate CMBS deals had jumped from interest rates in the 2.75% to 3% range to rates of 4% and 4.25%,” an article from the Self-Storage Association noted. Due to a rise in interest rates, the cost of capital will go up, and transaction activity will slow down as cap rates rise and sellers decide to hold their assets before they start to adjust their expectations to the market.
Insights from the Self-Storage Association also revealed that the interest rate hikes will likely impact construction activity, as most developers with projects well underway have floating-rate debt. However, these borrowers can rely on tools such as interest rate caps or swap transactions to protect themselves against interest rate risks.
Positive Outlook Lingers
In an interview with Storable, Talonvest Capital’s Co-Founder Tom Sherlock said that the interest rate hikes urged borrowers to accelerate their refinancing plans, and the company directed these opportunities toward life companies, banks, and credit unions offering early rate locks to shield clients. Sherlock also mentioned that as the initial wave of reacting to rising interest rates eased, construction loans and value-add acquisition opportunities became the primary deal drivers in the sector.
Although the Fed has continued to raise the benchmark interest rate, bringing it into a range of 1.5% to 1.75% in June, interest rates are still historically low, and there’s still time to secure favorable terms to protect properties against future economic uncertainties, according to Commercial Property Executive. The best terms to secure under current circumstances are longer-term, fixed-rate loans and balance sheet loans, the article revealed.
In the meantime, the rising interest rate environment also created opportunities for borrowers, as prepayments based on defeasance or yield maintenance are now cheaper, providing more flexibility for exit to sale or refinance ahead of their maturity, CPE noted.
Related Questions
What are the potential impacts of an interest rate hike on self-storage businesses?
The potential impacts of an interest rate hike on self-storage businesses include higher cost of debt capital, tighter underwriting, and buyers pulling out of deals. According to Multi-Housing News, stabilized properties will continue to trade, however, whether deals materialize will depend on the investors’ strategies. Transitional assets, those with value-add opportunities, could also withstand market volatility if investment strategies are executed right. Overall, both investors and lenders will likely flock toward multifamily assets during this uncertain period in search of stability.
Self storage businesses are relatively resilient to recessions due to their low operating costs and reliance on multiple tenants. According to Commercial Real Estate Loans, if a self-storage property is relatively well located and offers what nearby residents or businesses need, it's unlikely that the tenant roster will change even as the economy worsens. Additionally, most self-storage properties have enough units where a handful of additional vacancies isn’t enough to push the asset’s finances into the danger zone.
How can self-storage businesses prepare for an interest rate hike?
Self-storage businesses can prepare for an interest rate hike by understanding their current loan terms and researching potential loan products that may be available. It is important to understand the terms of the current loan, such as the interest rate, loan amount, and repayment schedule. Additionally, it is important to research potential loan products that may be available, such as adjustable rate mortgages (ARMs) or fixed rate mortgages (FRMs). ARMs typically have lower interest rates than FRMs, but the interest rate can fluctuate over time. FRMs have a fixed interest rate, but the loan amount may be higher than an ARM. Additionally, self-storage businesses should consider the impact of an interest rate hike on their cash flow and budget accordingly.
What strategies can self-storage businesses use to mitigate the effects of an interest rate hike?
Self-storage businesses can use a variety of strategies to mitigate the effects of an interest rate hike. One strategy is to take advantage of fixed-rate loans, which can help to lock in a lower interest rate and protect against future rate hikes. Additionally, businesses can look into adjustable-rate mortgages (ARMs) and hybrid ARMs, which offer a fixed rate for a certain period of time before adjusting to a variable rate. Businesses can also consider refinancing their existing loans to take advantage of lower interest rates. Finally, businesses can look into alternative financing options such as private lenders, which may offer more flexible terms and lower interest rates than traditional lenders.
What are the long-term implications of an interest rate hike on self-storage businesses?
The long-term implications of an interest rate hike on self-storage businesses depend on the strategies of the investors and the flexibility of the rental terms. Self-storage businesses are generally more resilient to economic pressures than other asset classes, such as office, retail, or hotels, due to their shorter lease terms and ability to adjust rents to reflect increasing operating costs and wider market conditions.
Industrial property leases tend to range between three and seven years, while self-storage leases generally are no longer than three months, with more and more just operating on a month-to-month basis. This flexibility offers an amazing opportunity to adjust rents to reflect increasing operating costs and wider market conditions.
Overall, as long as demand for self-storage space is consistent, self-storage businesses should be able to withstand market volatility.
How can self-storage businesses adjust their financing strategies to account for an interest rate hike?
Self-storage businesses can adjust their financing strategies to account for an interest rate hike by exploring alternative loan products with lower interest rates. For example, they could consider an SBA loan, which typically has lower interest rates than conventional loans. Additionally, they could look into adjustable-rate mortgages, which allow them to adjust their interest rate as market conditions change. Finally, they could explore other financing options such as private equity or venture capital.
For more information on financing a self-storage investment, please visit Commercial Real Estate Loans.
What are the best financing options for self-storage businesses in the face of an interest rate hike?
The best financing options for self-storage businesses in the face of an interest rate hike are SBA loans and commercial real estate loans. SBA loans are government-backed loans that offer low interest rates and long repayment terms, making them a great option for businesses that need to borrow money. Commercial real estate loans are also a good option, as they typically have lower interest rates than conventional loans and can be used to purchase or refinance existing self-storage properties. Additionally, some lenders offer special financing programs for self-storage businesses, such as interest-only payments or deferred payments.
For more information on financing options for self-storage businesses, please visit Commercial Real Estate Loans' Beginner's Guide to Self-Storage Investing.