Death, Taxes, and Other Reasons to Invest in Self-Storage

June 21, 2021
Categories: All Taxes Getting Started

It may come as no surprise that Americans like to buy stuff, and lots of it. In fact, consumer expenditures in the USA are higher than China, Japan, Germany, India, the United Kingdom, and France combined. Once consumers in the U.S. buy stuff, they do not like to throw it away.

Self-storage properties offer a solution for people and businesses who have too many things but not enough space to store it in.

Over 13.6 million households in the U.S. rent a self-storage unit. With about 2 billion rentable square feet, there's about as much self-storage space as there is office space in the Northeast and Midwest combined.

In this article, we will explain how the self-storage industry is delivering some very robust returns for commercial real estate investors, and why there are plenty of reasons to invest in self-storage other than just death and taxes.

Related: How to Build a Real Estate Portfolio That is Recession-Proof

Benefits of Investing in Self-Storage

Self-storage properties meet the overwhelming demand from people and businesses who do not have enough space for all of their things.

The Self Storage Association reports that there are more than 54,000 self-storage facilities in the U.S. generating over $35 billion in annual revenue. According to SpareFoot Storage Beat, about 10.6% of the households in the country rent a self-storage unit and an average rent of over $89 per month.

While some commercial real estate asset classes struggle for tenants, the self-storage industry continues to out-perform year after year. By 2025, the valuation of the self-storage market is expected to reach $115.62 billion, representing a compound annual growth rate (CAGR) of 134.79% since 2020.

Level of demand

A cap rate, which stands for capitalization rate, is a metric used to evaluate the profitability of a real estate asset. As described in more detail below, it is calculated using the ratio of NOI (net operating income) to value. For example, if a property has $100,000 in NOI and is valued at $1 million, it would have a cap rate of 10 percent. In this case, we would say that the investors are getting a 10 percent return on their money.

Tax benefits

Common tax benefits for self-storage investors include deductions for property tax, interest expense, and depreciation. Depreciation is a non-cash deduction that is used to reduce taxable net income, which can be very beneficial when a self-storage investment is held in a taxable portfolio.

For example, assume an investor owns a 10% share in a private equity self-storage investment worth $1 million (excluding the value of the land). The IRS allows commercial real estate to be depreciated over 39 years.

With a total annual depreciation deduction of $25,641 for the entire project, the investor's 10% share of depreciation would be $2,564 that could be used to reduce overall taxable income. If the sponsor of the self-storage joint venture uses an accelerated depreciation schedule, the tax savings from depreciation would be even greater.

Rent growth

Self-storage tenants are generally not sensitive to periodic rent increases. In part, that's because people need a place to store all of the stuff they can't do without. Another reason that self-storage operators can increase rents while still maintaining a high occupancy level is that the monthly rent on a self-storage unit represents a small percentage of the tenant's discretionary income.

The national average rent for all unit sizes of self-storage is $89.12 per month, through the end of 2020. That is less than what the average cell phone bill costs in the U.S. Last year, self-storage average rent growth in the most popular unit sizes was about 2%.

Depending on the market and general supply and demand factors, some self-storage operators enjoy rental increases of 5% - 8% or more. Because the cost of operating a self-storage facility does not increase nearly as much as the rent, the majority of the extra cash generated from rising rents increases NOI and returns for self-storage property investors.

According to Forbes, self-storage investments averaged an annual ROI of 16.9% between 2009 and 2018. In fact, the return on investment from self-storage facilities was higher than other commercial real estate such as retail, office, multifamily, and industrial over the same 10-year period.

Self-storage properties can also offer the opportunity for incremental revenues increases that further increase ROI. Ancillary products such as boxes, packing tape and pads, door locks, and dust covers are high-margin items that tenants are not likely to shop around for when they're already in the retail area of the self-storage office.

Resistance to recession

During the Great Recession of 2008, self-storage real estate investment trusts (REITs) were the only real estate asset type that generated positive returns for investors, according to Inside Self Storage. More than one year into the pandemic, it appears that Covid is helping rather than hurting the self-storage industry this time around as well.

For example, many colleges and universities have yet to begin teaching in-person again, creating demand from students ousted from the classroom. Migration trends from densely populated urban areas to the suburbs and smaller secondary markets over the past year are also driving demand for self-storage space while people try to find a place to live.

The self-storage industry is also benefiting from small businesses that have temporarily shut down and need a place to store equipment, furniture, and fixtures until the economy begins to rebound.

Even when the economy returns to normal, businesses are still big users of self-storage space. Contractors need a safe place to store their equipment, landscapers need quick and easy access to tools, and retailers and e-commerce companies use self-storage units to store promotional displays and additional inventory that's waiting to be shipped.

Related: How to Use Real Estate as a Hedge Against Inflation

Low maintenance

Self-storage properties are also inexpensive to build and easier to operate and maintain compared to other types of commercial real estate. For example, the average construction cost of an apartment building is $229 per square foot, not counting additional costs such as architect fees, land purchase, landscaping, and parking lots.

By comparison, typical self-storage construction costs range between $25 - $40 per square foot for single story construction, and between $42 - $70 per square for a multi-story self-storage building, excluding the cost of land and site improvements.

The final infrastructure of a well-designed self-storage development is relatively straightforward as well. Critical components of the best self-storage projects can include lighting and climate control, a good security system, fire sprinklers and an alarm system, all critical components of the best self-storage projects.

Self-storage properties generate an average national rent of about $11 per square foot, about the same as apartment rentals in many cities across the U.S. However, managing and maintaining a self-storage project is much less expensive than other types of commercial real estate.

Average operating costs for a self-storage facility range between $2.75 - $3.25 per square foot, compared to an average of $3.50 - $5.00 for multifamily, office, and retail properties.

Assuming a self-storage property is 46,000 square feet, gross rental income would be about $500,000 each year. With annual operating expenses running less than $140,000, an average self-storage investment in this example would produce an NOI of $360,000 per year.

Self-Storage Demand

They say that in life, the only sure things are death and taxes. In the self-storage industry, there are four sure things: Death, Divorce, Downsizing, and Displacement.

While these occurrences may not be the best for tenants, when combined they create significant demand for self-storage property in every market across the U.S.

Death

Managers of a self-storage property require legal documents to turn over the codes and keys to the deceased's unit, and during the meantime the leasing obligations continue. Even when the keys are turned over, settling an estate can take over a month in many jurisdictions, which means the rent will need to be paid until that time.

When everything is said and done, the heir may take possessions out of the property, or continue to pay rent on the unit if there is no place to move the loved one's belongings to.

Divorce

Between 40% - 50% of first-time married couples in the U.S. get divorced, and the divorce rate for subsequent marriages even higher, according to the American Psychological Association (APA). With statistics like these, it probably goes without saying that divorce is another reason why demand for self-storage space is so strong.

People going through a divorce rent self-storage units for a number of reasons.

First and foremost, they may simply have no other choice. When people get divorced, they frequently move in with a friend and use a spare bedroom until the divorce is finalized. While they have a place to sleep, they also need a place to store all of their belongings.

Avoiding having to return to their previous home is another reason divorced people use self-storage space. Keeping personal items in storage such as clothing or power tools avoids having to see the former loved one face-to-face.

Finally, people getting divorced keep their stuff in storage because they want to start over again with a clean slate. Until they know what they will need in their new life, people keep things in self-storage until they decide what to keep and what to sell.

Downsizing

Signs that it's time to downsize include housing expenses rising above 30% of the household budget, little or no money left over after all of the bills have been paid, and the ability to work remotely. For better or for worse, that describes a large percentage of the population today.

Because the average self-storage unit rents for less than $90 per month, people on a tight budget often choose to rent a storage space to keep the things they know and love.

For people working from home, turning a spare bedroom into an office often means putting other furniture into storage for an extended period of time. Keeping things in storage during uncertain economic times also gives people more peace of mind without having to worry about how much extra space they will have once they do eventually downsize.

Displacement

People need to declutter before they move, and the path of least resistance is often to rent a self-storage unit to store keepsakes, excess furniture, and boxes. Because storage units have such a low price point, people usually do not think twice about renting, even if the unit never gets filled up.

Of course, the current pandemic has also displaced both homeowners and renters who have temporarily moved to a nearby city or smaller place who need extra space to store their things. Until things return to normal, self-storage tenants are hesitant to throw things away, especially when the price of almost everything seems to be going up.

Conclusion

In nearly every city across the U.S., it is impossible to drive down the street without eventually seeing some self-storage space. Over the next five years alone, the value of the self-storage industry is forecast to have a compound annual growth rate of nearly 135%.

When you look at the numbers, it is easy to understand why self-storage properties are so appealing to investors.

Gross rental income from a self-storage unit is about the same as the rent for an apartment in many cities, when measured on a per-square-foot basis. Operating expenses of a self-storage facility are about 50% less than other commercial property types such as multifamily and office.

The extra net operating income that self-storage properties produce compared to other investments can generate some pretty impressive returns for the passive income investor.

Related: Top 20 Mistakes that Self-Storage Developers Make that You Need to Avoid