by Ben Vestal
Looking back at the first six months of 2010, there is no doubt that real estate transaction volume has improved significantly compared to most of 2009. This is largely due to an adjustment in the two most critical factors that affect confidence; fear and greed. Over the last six months we have seen a much improved attitude toward acquisitions and most self storage professionals are feeling more confident in their ability to perform as the shock of the GREAT RECESSION is starting to wear off. Most of the fear that was in the market during 2009 was created by the unknown factors in the financing market and an overall slow down in the economy. As we start to wind the clock on the last six months of 2010 we are beginning to see improvements in the financing market and, most importantly, we are confirming that self storage is no doubt one of the most recession-resistant real estate assets.
The uncertainty and fear in the market during 2009 was generally created by the unknown factors that were floating around on the balance sheets of many major banks. The one question out there that still seems to be unanswered is how banks will handle maturing loans where the collateral is no longer worth the balance of the loan. Many of you have probably heard the term "extend and pretend" by now, as most banks have tried to work with their borrower to extend the loan and allow the borrower the necessary time for the market to recover. It seemed that for most of last year the few buyers that were in the market were waiting for distressed asset opportunities to come to market, hoping that they would not be overpaying. Since it was very difficult to assess the market value of real estate due to the lack of transactions, they were simply relying on the assumption that if it was distressed, then they would not be overpaying. The reality is that there were actually very few distressed sales that took place in 2009. The ones that did come to market were sold in a non-competitive environment which created a tremendous opportunity for the buyers that had access to these deals. The majority of distressed opportunities that sold were placed in a biding process where they were so actively chased that it left me wondering if the winning bidder had actually paid a distressed price. In any event, the few transactions that took place in 2009 were setting the values and, more importantly, the rules for which properties were now going to be valued.
The transactions that have taken place in the first half of 2010 have substantially outpaced the volume of the first half of 2009. We believe that the transaction market for the second half of 2010 should continue to improve with opportunistic and market rate deals dominating most of the transactions. I do believe that there are some situations within the self storage industry where a lending institution has implemented the philosophy "extend and pretend" where the debt of the properties will not reach the value of the loan even with the improving market conditions. The majority of these "distressed" opportunities will be for larger portfolios and will mostly likely be sold to large self storage operating companies that have the ability to buy several properties within one transaction. It is our observation that the demand for self storage properties is strong and there are several well-capitalized buyers in the market today. These buyers are experienced and very disciplined in their underwriting and are not willing to overpay for properties. The buyers that are winning deals in today's market are not winning them on price alone. Buyers are relying on other factors such as timing, due diligence and experience to win deals. For sellers, this means that their selection of a self storage broker is even more critical as the broker will be responsible for guiding his client through an ever complex real estate environment where the broker's problem solving ability, experience and depth of resources are vital to the success of the transaction.
We are also noticing that there is a substantial bifurcation in the market today between properties located in major markets with values of over $3 million, and smaller, less valuable properties. We are seeing the higher value properties achieve cap rates that are 100 to 300 basis points lower than smaller properties. This is due to several factors; the large, well-capitalized buyers in the market today are unable to obtain smaller loans at a competitive rate that is necessary to make the smaller deals work. Additionally, they are unable to achieve the economies of scale necessary to make their new financial model work. These factors combined with the high cost of the legal work and the complex nature of the larger operator's capital has made it very difficult for larger operators to consider smaller transactions in today's market. This has left the smaller operators wondering why they can't sell their property for the same cap rate as the larger properties in their same market. The smaller operators today are dealing with buyers that are not as well-capitalized and, more importantly, banks that are less aggressive with interest rates and terms due to the small nature of the transaction. I believe that smaller, less valuable properties will be valued differently than larger, well-located class "A" properties for several years to come.
There is every indication that the transaction market is improving, with market rate deals dominating the majority of the transactions. This has led to clarity in pricing and added confidence to the financing markets. Additionally, the concern about a possible double dip recession, rising interest rates and the likelihood of an increase in capital gains tax has led some of the most sophisticated owners in the business to consider selling in today's improving market. Clearly, any of these events could have a material impact on the owner's investment if the investment's horizon is short term, say less than three years. Thus, if you are planning on selling sometime in the not too distant future, you may want to give some thought to accelerating the process to take advantage of a buyer's ability to borrow money at low interest rates and lower capital gains tax.