Over the past few years, I have spent quite a lot of time working with institutional investors looking at self-storage. The initial attraction is usually easy to understand.
The sector has many of the characteristics investors like. Revenue comes from a very large number of individual customers rather than a handful of tenants. Leases are short, which allows rents to respond relatively quickly to market conditions. Maintenance and recurring capital expenditure are generally limited and relatively predictable. Demand comes from many different sources and, once a facility reaches stabilised occupancy, cash flow tends to become highly visible and relatively predictable. At the same time, short leases and a granular customer base leave room to continue growing revenue through pricing.
There is also a compelling growth story in many European markets. Ownership remains fragmented, the sector is still developing, and there appears to be plenty of room to create larger professional platforms.
Put all of that into an investment presentation and self-storage can look almost tailor-made for institutional capital.
The difficulty starts when you try to deploy the money.
Capital wants scale. Self-storage comes one building at a time.
This is where the investment thesis starts to become more complicated.
Institutional investors need to put meaningful amounts of capital to work. A €5 million or €10 million self-storage investment may be perfectly attractive on its own, but it doesn’t move the needle very far for a fund looking to deploy €100 million or €200 million into the sector.
Self-storage, meanwhile, has traditionally grown one facility at a time.
The obvious shortcut is to acquire an existing portfolio or platform. You get scale immediately, usually together with an operating business, a management team and facilities that are already generating cash. The problem is that good platforms don’t come to market very often and, when they do, there is usually plenty of capital competing for them. Much of the value creation has already happened, and the price tends to reflect that.
Building a platform offers a different proposition. Instead of paying someone else for having found the sites, developed the facilities and taken them through lease-up, you can potentially capture that value yourself. You also have much greater control over location, building quality, unit mix, branding and operating systems.
I’ve generally found that part of the argument relatively easy to make. The difficulty is what follows from it.
If the strategy is to build ten or twenty facilities, you still have to find ten or twenty good sites. You have to negotiate each acquisition, obtain the necessary approvals, build each property and then lease it up. The portfolio may eventually represent a substantial amount of invested capital, but it doesn’t arrive as a portfolio. It has to be assembled.
And that takes time.
The IRR clock starts before the platform is ready
Time is probably the tension I’ve encountered most often.
A development strategy may produce an attractive return on paper, but institutional capital is very sensitive to how long it takes to produce that return. Capital needs to be deployed, and the longer it remains invested before the value is created, the greater the pressure on IRR.
Self-storage development operates on a rather different timetable.
Finding the right property can take months. Negotiating the acquisition takes more time. Planning or licensing may be straightforward in one municipality and surprisingly difficult in the next. Then there is design, construction and fit-out.
And opening the building is not the end of the process.
A self-storage facility still has to fill.
That last point is particularly important. With many property developments, completing and leasing the building substantially completes the business plan. In self-storage, opening the doors is really the beginning of another phase. Thousands of individual customers have to be acquired, one by one, before the facility reaches stabilised occupancy.
That can take several years.
The facility may be performing exactly as expected during that period. Occupancy may be building according to plan, rents may be moving in the right direction and the eventual stabilised economics may look very attractive. But the cash flow and value that justified the original investment are still being created.
This creates an uncomfortable mismatch. Development is often where some of the best value can be captured, but it is also the route that takes longest to produce a stabilised portfolio.
Buying existing facilities solves much of the timing problem. The income is there from day one, capital can be deployed much faster and there is considerably more visibility over performance. But, of course, you pay for that certainty.
This is where the IRR clock can begin to affect strategy. There is a natural temptation to accelerate deployment, whether by paying more for existing facilities, accepting sites that might otherwise have been rejected, or taking on several developments simultaneously.
None of those decisions is necessarily wrong. But I’ve found it useful to distinguish between moving quickly because the opportunity is good and moving quickly because the capital needs to be deployed.
They are not always the same thing.
A pipeline is not a portfolio
A business plan can make expansion look wonderfully orderly.
Three facilities acquired in year one, four in year two, another five in year three. Add the investment assumptions, construction periods and lease-up curves, and a platform begins to appear on the spreadsheet.
The reality is rarely so cooperative.
A market study may identify a city with attractive demographics, limited competition and apparently strong demand. That doesn’t mean there is a suitable property available there at a price that makes the numbers work.
Self-storage has fairly specific real estate requirements. You need the right catchment and reasonable access. The building or land needs to work physically. Planning has to allow the use. Construction costs have to make sense. And after all of that, the acquisition price still has to leave enough room for an acceptable return.
Finding one site that satisfies those conditions is manageable. Repeating it ten, twenty or thirty times while keeping to an investment timetable is considerably harder.
This is why I tend to be cautious about perfectly regular acquisition programmes in business plans. They are necessary for modelling purposes — we need to put dates somewhere — but they can create a false sense of certainty.
Some years the opportunities appear. Sometimes they don’t.
The real test comes when they don’t and there is committed capital waiting to be deployed. Maintaining investment discipline is relatively easy when you have no pressure to buy. It becomes much more difficult when the business plan says you should already have bought three properties.
The operating platform has to come before the portfolio
Finding the properties is only part of the problem. You also need people who know how to operate them.
This becomes particularly noticeable when entering a less mature self-storage market. There may be plenty of experienced property, construction, finance and marketing professionals, but relatively few people who have actually opened a self-storage facility, taken it through lease-up and then operated a multi-site portfolio.
That experience matters more than it might appear from the outside.
Self-storage is not a particularly complicated business, but there are a lot of small decisions that affect performance. Unit mix, pricing, promotions, revenue management, sales conversion, collections, local marketing, staffing and customer service all matter. None is especially difficult in isolation. Getting all of them consistently right across several facilities is what eventually makes a good operating platform.
Some of this can be learned, and people can certainly be recruited from adjacent industries. But there is a difference between understanding the principles and having seen what actually happens when a new facility opens with almost no customers, when one unit size fills much faster than expected, when enquiries are strong but conversion is poor, or when occupancy looks good but average rent doesn’t.
Those are operating problems rather than real estate problems.
In established self-storage markets, there is usually a pool of experienced operators who have dealt with them before. In younger markets, that pool can be surprisingly shallow or sometimes almost nonexistent.
For an investor building a platform from scratch, this creates another sequencing problem.
You cannot wait until you have ten facilities before building the management team. The operating systems, pricing strategy, marketing capability, reporting and management structure need to be in place much earlier. Ideally, much of it needs to be ready before the first facility opens.
But a team capable of operating ten facilities can look expensive when it is operating only one or two.
I’ve encountered this tension several times. On a property-by-property model, the central overhead can look excessive in the early years. The natural response is to keep the organisation as lean as possible and add people later.
There is obviously some sense in that. But take it too far and you risk saving money precisely when the operating platform is being established. The first facilities are where processes are tested, people learn the market and the operating model starts to take shape.
What looks like excess overhead at the beginning may actually be part of the investment required to create the platform.
Scale is more than the number of properties
This is also why I think there is an important distinction between assembling a portfolio and building a platform.
A portfolio can simply be a collection of properties. A platform should become something more.
It has a management team, operating systems, customer acquisition capability, pricing and revenue management, data, a brand and, ideally, a pipeline capable of producing the next generation of facilities.
As the business grows, those things start to create economies of scale. Marketing can be managed centrally. Revenue management becomes more sophisticated as the data improves. Technology and systems are spread across more facilities. Management costs become smaller relative to revenue. Lessons learned in one facility can be applied to the next.
Eventually, the infrastructure that looked expensive when there were two properties becomes one of the things that makes the larger business valuable.
That matters at exit as well.
A buyer looking at twenty individually managed self-storage properties is not necessarily looking at the same investment as a buyer looking at twenty properties supported by an experienced management team, common systems, reliable operating data, an established brand and a credible development pipeline.
The buildings may be identical.
What surrounds them isn’t.
And that difference matters because scale can change not only how efficiently the business operates, but also who is able — or willing — to buy it.
The exit rarely arrives at the perfect moment
A development platform does not mature all at once.
By the time the first facilities reach stabilised occupancy, the next group may still be leasing up and the most recent developments may only just have opened. There may also be sites under construction and others still moving through planning.
Yet the institutional investment period continues to move forward.
This creates a question that is easy to overlook when the original business plan is being prepared: what exactly will the investor own when the time comes to sell?
A portfolio of ten stabilised facilities is relatively straightforward to value. There is operating history, visible cash flow and evidence of what each property can produce.
A platform with three stabilised facilities, four in lease-up, two under construction and another five sites in various stages of the pipeline is different.
There may be considerably more value still to come, but some of it remains to be proven.
The seller will naturally want credit for that future value. The buyer will naturally want to discount it for the work and risk that remain.
This doesn’t mean an investor has to wait until every facility is mature before selling. In many cases that would make little sense. A credible development pipeline, an experienced team and a demonstrated ability to open and lease facilities successfully can themselves be valuable.
But not every pipeline has the same value.
A list of cities where the company would like to open facilities is an ambition. Sites under control, planning advanced, developments under construction or projects approaching opening are something quite different.
The timing of the exit therefore has a significant effect on how much of the value being created by the platform is captured by the original investor.
Waiting gives more facilities time to stabilise, makes their performance easier to demonstrate and reduces some of the uncertainty a buyer has to price.
But waiting also extends the investment period.
The IRR clock has not gone away.
Paying for the value or creating it
I don’t think any of this weakens the case for institutional investment in self-storage.
If anything, the continued development of the sector suggests the opposite. A scaled, well-run self-storage platform can have many of the characteristics institutional investors were looking for in the first place: diversified and visible cash flow, pricing flexibility, operational scale and a portfolio large enough to attract substantial capital.
But there is an important distinction between buying that platform and creating it.
Buying an established business gives an investor immediate scale, cash flow, operating capability and usually a management team that already knows the business. It also removes much of the uncertainty around development and lease-up.
The disadvantage is straightforward: you have to pay for all of that.
Building the platform offers the possibility of capturing more of the value yourself. But that additional value doesn’t appear for free. It comes from accepting the development risk, lease-up risk, operating risk and execution risk that the previous owner would otherwise have taken.
Above all, it requires time.
That is the paradox I keep coming back to.
Institutional investors are attracted to self-storage because of what a scaled, stabilised platform can become. Creating that platform, however, requires accepting many of the things institutional capital would normally prefer to minimise: relatively small individual investments, uncertain deployment schedules, development risk, operating build-out and a long period before the portfolio is fully mature.
So perhaps the choice is not really between buying self-storage and building self-storage.
It is between paying for a platform somebody else has already created and accepting the time and execution risk involved in creating that value yourself.
Both can make sense.
But they are very different investment propositions.
The attractive part is the finished platform. The difficult part — and often the source of the return — is everything that has to happen before it exists.