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Economic Outlook for SS

GUEST BLOG: Economic Outlook for Self Storage – The Tail of the Cycle

Submitted to Investment Real Estate by Paul Sloate, Founder and CEO of Green Drake Advisors

For the Real Estate Investor, the cycle tells all. Early in the economic cycle, opportunities abound, but money does not. And as time progresses, the money becomes more and more available, but the opportunities become less available. Unlevered returns begin to dwindle and maintaining the return on an individual property investment only occurs by adding debt. In addition, once property values soar and unlevered returns drop, construction accelerates, as building properties creates higher returns and value for the sponsor as long as real estate prices remain high. This works until the inevitable downturn that lowers occupancies and cash flow leading the banks and other providers of credit to restrict their availability and raise its cost. This, in turn, causes property values to drop and shuts off new construction, as the economics no longer work to build a new building. Once the overall economy bottoms and turns upward, the Real Estate Cycle starts all over again.

Currently, the US economic cycle stands in a late cycle position, where property values have soared and construction is booming. In other words, we are at the beginning of the Tail of the Dog. The Real Estate Investor should think of the Real Estate Cycle as a Dog going by. Early in the cycle the Head appears, signaling opportunity. But there are no feet, what the investor would call available credit, to support real estate investing. Then the Body and Front Legs show up. Credit becomes somewhat available and opportunities abound. As the dog continues to pass and the Hind Quarters and Legs appear, credit progressively becomes looser but the real opportunities dwindle. And, as the Tail appears, the yellow warning light blinks signaling the red light of a downturn ahead.

Today, the Tail is beginning to appear as a result of the Federal Reserve’s actions over the past two years. The most important signal of these actions, the Yield Curve, indicates a significant economic slowdown in progress with the potential for ending the cycle.

Yield Curve Chart

This chart shows the difference between the 10 Year Treasury Note and the 3 Month Treasury Bill. Every time this difference dips below zero, over the last 40 years, a recession follows within a couple of years. There is an exception to this rule, just as in spelling “i” comes before “e” except after “c” and when used like an “a” like in “neighbor” and “weigh” and a number of other exceptions. These exceptions, for the Yield Curve, happen when the Federal Reserve reverses course and eases aggressively to offset the tightening they created. This occurred in 1998 and 1966. Whether the Federal Reserve will ease aggressively or not, appears unclear. And even should they ease aggressively, the extension to the cycle historically does not last more than 2 1/2 – 3 years.

For the Real Estate Investor, this clear signal means caution should abound. And, for those in the Self Storage Industry, even more caution should abound, as construction soared over the past several years, while a potential economic downturn looms ahead. The following chart shows how construction in the Self Storage Industry soared over the past 4 years to a level four times where it stood in 2006, at the peak of the last building cycle for the industry:

Self Storage Construction Spending Chart

As the chart demonstrates, the industry continues to add significant capacity. Public companies in the industry already have reported a significant slowdown in Same Facility Revenue Growth to less than 2% year over year in 2018, before much of the capacity under construction comes online. At the same time, industry costs accelerated, reaching an annual increase in the 3.0% to 4.0% range, as labor, taxes and IT costs continue to rise. This squeeze began to put pressure on Same Store NOI Growth, which will likely continue as self storage facilities under construction come online.

Given this environment and with the economy in a late cycle position, balance sheets will soon matter for the Real Estate Investor. The light blinks yellow as the Tail is appearing. And should the Federal Reserve not ease aggressively, the light will turn to red as the Tail passes, the economy turns down, credit dries up, and values drop. With “The Tail of the Cycle” at hand, danger stands directly ahead. But for those investors able to navigate the next few years, future opportunity will abound as the Head once more appears and the cycle starts all over again.

Greendrake Advisors LogoIf you have questions about the self storage economic cycle and would like more information, you can visit Green Drake Advisors’ website to put their industry expertise to work for your self storage facility.

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About the author:

Paul SloatePaul Sloat, Greendrake Advisors is the Founder and Chief Executive Officer of Green Drake Advisors. He has spent over 30 years advising individuals, families, businesses and institutions on wealth management, wealth planning and global economics, serving in senior roles with companies such as Wellington Management and BlackRock Financial Management. Mr. Sloate has appeared on TV on numerous occasions to share his expertise with the public and hosted Money Matters TV for many years. In addition to his time given to sharing his knowledge, Mr. Sloate has served on industry bodies such as the Financial Accounting Policy Committee of the Association for Investment Management & Research. Mr. Sloate is highly involved in giving back to the community. He supports numerous non-profit organizations, serves on a private company Board, and lectures often in the Philadelphia area on investing and economics. In his spare time, Mr. Sloate is an avid fly fisherman and teaches karate.

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