The Best Performing Real Estate Asset Isn't What You Might Think

Nathan Slaughter's picture

Tuesday, July 30, 2019 - 12:00am

by Nathan Slaughter

"It's just too much space." 

That seems to be the consensus opinion among many retirees when surveying the homes they have lived in for the past 10 to 20 years. These empty-nesters wake up one morning and realize they no longer need a 5-bedroom, 5,000 square-foot residence on a corner lot -- or the property taxes, maintenance, and upkeep that go with it.

Young couples naturally aspire to move into larger houses to accommodate growing families. But once the kids are gone, mom and dad often feel the need to downsize. So they pack up and move to a smaller home, or maybe a condo. 

This has been the pattern in previous generations, and we're starting to see it unfold again with today's Baby Boomers. Keep in mind, every single day approximately 10,000 boomers reach the age of 65 -- over a quarter-million per month. And that wave will continue for another 15 years. 

It's not just a matter of space. There are other reasons that motivate millions of people to relocate each year. Some want to move closer to children and grandchildren. Others want to escape cold winters and play golf year-round. 

Still, others are looking to cash out some of the equity in their homes to provide supplemental retirement income. And there's plenty of that. According to a Federal Reserve survey, homeowners above the age of 55 control nearly $8 trillion in combined home equity -- about two-thirds of the nation's total. 

An Unexpected Level Of Returns
I know what you might be thinking. How does this downsizing cycle benefit me as an investor? Well, let me ask you this: Have you ever moved? If so, then I'm betting your belongings didn't all take a direct flight to their final destination. Some of your stuff may have had a layover in a storage rental unit. 

When it comes to real estate, we tend to picture sleek high-rise office towers or massive retail developments anchored by national chains, not tiny 10-by-10 square-foot boxes. Believe it or not, though, the self-storage industry has consistently delivered the highest investment returns of all property groups. 

The monthly rent checks may be small, but they're also plentiful -- allowing for spectacular dividend increases of up to 680% over the past five years. 

50,000 Locations And Counting
The fact is, American families typically have more stuff than they really need. Some of these items get donated to charity or wind up in the dumpster. But there are many things that we just can't bear to toss out. 

The easiest way to de-clutter is to move these seldom-used possessions into a storage unit.

Back in 1995, there were about 25,000 self-storage facilities nationwide. But they have been popping up at a rate of 1,700 per year on average. The number of locations doubled to 50,000 and continues to grow. According to the Self-Storage Association, these warehouses contain 2.3 billion square feet of space for rent.

On average, there are about four new self-storage facilities opening per day. Even with capacity doubling, national occupancy rates have remained stable around 85%. Meanwhile, average monthly rent for a 10 x 20 square foot unit has increased to around $100. In other words, every time a new unit is built, there is somebody waiting to fill it with their stuff -- and the average lease period is 12 to 18 months. Safekeeping old bed frames and television sets may not be the most glamorous business. But these facilities are generating annual rental income in excess of $24 billion. 

And that figure continues to grow. 

This is a fragmented market with thousands of small local competitors that own only one or two locations. But industry consolidation has concentrated the lion's share of the profit among a small handful of large national players. And this group has historically posted the strongest returns of all major real estate asset classes.  

The National Association of Real Estate Investment Trusts (NAREIT) examined stock prices over a 15-year period between 1997 and 2011. Over that span, it found that the self-storage property sector posted average annual returns of 15.4%, beating out apartments (13.7%), retail (13.5%), office (10.4%) and industrial (8.7%). 

Rising stock prices and dividend distributions have been accompanied by steadily growing earnings among these operators. And 2017 looks to be the best year yet. Self-storage properties are projected to see cash flow growth of 12.4% next year, versus 7.7% for apartments, 5.5% for retail, and 5.0% for office properties. 

Now, this trend isn't driven solely by baby boomer downsizing. The storage industry benefits from each of the "four 'D's": divorce, death, density and dislocation. In reality, any major life event can trigger the need for storage... college graduation, marriage, career change, not to mention catastrophic weather such as floods and hurricanes. 

Whatever the cause, usage has never been higher. As I write, occupancy rates are close to 90%. And that's just one of many reasons I love this industry. 

Consider the following:

-- Moving stuff around town is a major hassle, so facility owners can usually pass along gradual rent hikes without driving away tenants. Revenues are sticky and recession- resistant. 

-- New capacity tends to be absorbed quickly, and barriers to entry are higher than you might think. In some cases, getting requisite permits to build new facilities can take years. 

-- According to real estate firm Cushman & Wakefield, the breakeven occupancy rate for a self-storage facility is approximately 40%, meaning even half-full locations can still profit. For comparison, the breakeven point for apartments is 60%. 

-- Capitalization rates (operating income as a percentage of property cost) approach 9%, among the best in real estate world. 

-- Net operating income (NOI) growth in the storage space has been outrunning other REIT sectors consistently for the past 20 years. 

Action To Take
Put it all together, and you start to see why this overlooked niche has delivered robust triple-digit returns to investors. And while I don't currently have exposure to this sector in my premium income newsletter, High-Yield Investing -- rest assured, I'm watching this sector closely for a timely addition to the portfolio. In the meantime, if you'd like to learn more about my newsletter (and get the names and ticker symbols of all of my picks), simply follow this link.

Nathan Slaughter does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.