by Philip Kibel

Often overlooked by investors in the past, self-storage facilities are management- intensive businesses with a heavy capital component in the form of property. Two important ingredients for a company's success in this industry is good facility management and creativity in providing additional services that strengthen competitive posi tioning and enhance revenues. Often-high levels of customer contact and interaction (especially commercial clients), constant lease rollover, and lack of much brand awareness require experienced and responsive on-site management.

The self-storage industry continues to be heavily populated by small local and regional businesses with substantial consolidation having taken place over the last few years. Public self-storage real estate companies have been among the most active industry consolidators due to their greater size, scope of operations and lower cost of capital. Brand awareness is also growing, and self-storage may become the first property sector with true retail brands.

Unique Characteristics Add to Industry Stability

Self-storage facilities' cash flows are inherently diversified by tenant and facility-factors that add stability to a company's cash flows. In this respect, self storage is similar to the apartment sector, where tenant concentration is also not an issue. Furthermore, in assessing a firm's geographical diversification, an important characteristic to keep in mind is the company's depth of presence in a particular market or markets. This helps reduce unit costs, improve marketing and advertising power, and assist in migrating tenants from high-occupancy facilities to nearby ones with lower occupancies. This is similar to the strategies of hotel operators under the same corporate flag.

Self-Storage Sector
# of REITs	4
Market Cap.	$6,040,000*
Industry Market Cap.	$142,858,000*
% of Industry	4.2%
Average Dividend Yield	6.2%
YTD Total Return	37.8%
1-year Total Return	42.7%
3-year Total Return	13.6%
5-year Total Return	12.5%
Weighted Daily Volume (shares)	237,170,698
Weighted FFO Growth (2001–2002)	8.6%
*These figures represented in thousands.
Data as of Sept. 27, 2001.
Source: NAREIT

However, most self-storage companies have similar standard features and characteristics, and hence it is hard to differentiate among facilities. In order to counteract this, self-storage real estate companies have increased branding and marketing efforts, some of which have yet to take hold. The commoditization of any product, self storage included, results in increased levels of price competition and favors more efficient operators. Therefore, larger firms—primarily the four publicly traded companies—have an edge over the smaller, independent operators. The four public self-storage real estate companies are Public Storage, Inc., Shurgard Storage Centers, Inc., Sovran Self Storage, Inc. and Storage USA, Inc.

In addition, the self-storage industry is subject to some seasonal swings. Residential customers, who are the most frequent users of self storage, are more likely to move during the summer months, thus affecting the sector's occupancies and revenues. In order to mitigate these swings, the self-storage companies have instituted marketing and operating initiatives to better attract and retain a larger commercial customer base. Examples of these programs include climate-controlled facilities, master leases for facilities in several geographic locations, and programs that allow real estate companies to customize storage spaces to fit the specific needs of its commercial customers.

The REIT Impact

REITs have had several positive effects on the self-storage industry. REITs' marketing strategies have increased product awareness, while their operating policies have improved efficiencies and helped provide synergistic services. Moody's believes that publicly traded self-storage companies will continue to be leaders in the industry. Along with providing more professional management to this too-often under-managed property group, REITs also provide crucial liquidity for this sector.

We believe that the management teams of the four self- storage REITs are doing sound and professional jobs assessing market dynamics and consumer needs. The companies tend to buy or build new facilities in markets with higher barriers to entry—a plus from a credit standpoint and a better defense against overbuilding. More importantly, these companies' management teams possess a significant knowledge of the industry and have well thought-out operating strategies.

While not the prevailing form of ownership in the self-storage industry, publicly traded real estate companies have many advantages over local and regional operators. Self-storage REITs are generally larger, better capitalized and more diversified than other participants in the industry. They are able to reap operational efficiencies, such as through toll-free calling centers, introduce professional management, and obtain lower costs of capital. The factors that distinguish self-storage REITs from the rest of the self-storage industry, and which separate the more successful from the less-successful real estate companies, are summarized below.

Marketing and Branding

Over time, the self-storage business is one real estate sector where a national brand name can be established and cultivated and is in fact one of the keys to long-term success for a self-storage company. Recent developments in this arena are the formation of strategic marketing alliances and the execution of targeted advertising campaigns. These developments increase consumer awareness and expand customer reach.

Operational Acumen

Operators with solid infrastructure and customer service functions have a competitive edge. An example of best practices among self-storage real estate companies is having a 24-hour call center that allows for centralized customer service and reservations. Publicly traded real estate companies enjoy comparatively large operating efficiencies, providing them an advantage over the rest of the industry.

Diversification and National Presence

Creditors and investors prefer companies with geographically diverse portfolios because they generate more stable cash flows. When one region declines, another may be on an upswing, thus diminishing the negative effects of portfolio losses stemming from the struggling region.

Location and Quality of Facilities

Self-storage owners with facilities that are highly visible and easily accessible also have a competitive advantage. Visibility and accessibility, along with facilities that are in good physical condition and are safe, provide a differentiating factor among both commercial and residential customers.

Innovative Products

The ability to innovate and introduce new products to meet evolving consumer needs is increasingly critical in this commoditized industry. Among the innovations that have been introduced are climate-controlled facilities, drop-off storage and 24-hour accessibility. Some new, costly innovations, such as portable storage, typically cannot be implemented by a "mom-and-pop" company and are another advantage for publicly traded real estate companies.

Providing Ancillary Products and Services to Customers

Another differentiating factor among self-storage companies is the menu of storage products and services being offered, and the effectiveness of a company in successfully selling such products. Typically, products range from locks and packaging supplies to property insurance and truck rentals. These added services not only cement customer relationships, but also increase revenues from complementary businesses.

For example, Public Storage, Inc., the largest self-storage company, has distinguished itself by creating a solid operational infrastructure. Public Storage's two national telephone reservation centers and its extensive advertising and marketing programs help it to optimize the utilization of available space and to set rental rates efficiently. In addition, the company has undertaken an initiative of establishing retail moving and storage supply stores within its facilities in high-traffic, high-visibility locations, fortifying its brand name while generating incremental revenues.

The self-storage industry has undergone significant transformation and growth over the last decade. The most important development for the industry has been its appearance, for the first time, on the radar screens of a broader cross-section of investors as a legitimate and attractive investment option. In short, the industry has gained credibility among a wider circle of potential investors—a reflection of its sound performance.

Philip Kibel is a senior analyst in the Real Estate Finance team at Moody's Investors Service.