By Merrie S. Frankel, Esq. and Philip Kibel, CPA

Unlike some other commercial real estate sectors, the self-storage property sector remains highly fragmented with numerous private, local owners, many of which are “mom-and-pop” operations. The five publicly traded self-storage REITs own about 9 percent of the 38,000 self-storage facilities in the U.S. However, consolidation is underway and the benefits REITs bring to the self-storage sector are becoming obvious.

REITs provide critical liquidity for this sector, and their success has made self-storage assets more mainstream investments than ever before. Self-storage facilities have many operating business characteristics that can be efficiently replicated across a wide portfolio of store locations. Because of this, the size and stability that REIT status can bring is a plus. Self-storage is also a management-intensive business. Often-high levels of customer contact and interaction (especially commercial clients), the need for constant lease rollover, and lack of much brand awareness (yet) require experienced and responsive on-site and back-office management that REITs can bring to the table.

Self-storage REITs continue to strengthen their position as leaders in the sector—with that leadership deepening and widening through acquisitions of private portfolios and new REITs entering the public market. Though the self-storage industry continues to be primarily populated by small local and regional owners, recent IPOs bode well for further consolidation as those newly public firms seek growth through acquisitions.

Operating Fundamentals

Moody’s Investors Service views the self-storage industry as a relatively stable property class. In fact, it is the least volatile of all the REIT sectors. It is more insulated from economic shifts due to the need for space both when the economy is weak (as people downsize in housing, double-up or move in with parents) and when the economy is strong (more disposable income and purchased goods requiring storage, as well as heightened demand from commercial users). The Self Storage Association’s 2005 demand study indicates that one in 11 (9 percent) of U.S. households now rent a self-storage unit—up from one in 17 (6 percent) households in 1995—a positive indication of product awareness and usefulness.

This stability is demonstrated by self-storage REITs’ low volatility, based upon return on average assets (ROAA) adjusted for nonrecurring items. The adjusted ROAA ranged from 6.01 percent in 2001 to 4.17 percent in the first quarter of 2005, as compared to a 2.97 percent adjusted ROAA for the overall REIT industry in the first quarter of 2005. The standard deviation is 0.534 versus the REIT industry’s 0.899.

Moody’s-Rated Public Self-Storage REITs
Company	Ticker	IPO Date	Moody's Rating	Equity Market Capitalization ($Mil)	# Properties	Gross Assets ($Mil)	Total Debt($Mil)	Recur EBITDA/ Int + Prf (X)	Total Debt/ Gross Assets
Public Storage, Inc.	PSA	July 1980	Baa1	8,195	1,480	6,484	152	3.03	2.3%
Shurgard Storage Centers, Inc.	SHU	March 1994	Baa3	2,112	623	3,413	1,811	1.51	53.0%
Sovran Self Storage	SSS	June 1995	NR	718	276	883	321	3.16	36.3%
U-Store-It Trust	YSI	October 2004	NR	711	236	1,019	489	2.51	48.0%
Extra Space Storage Inc.	EXR	August 2004	NR	447	148	946	559	1.74	59.1%
Source: NAREIT; SNL, data as of 2Q05. Ratings on senior debt or shelf.

Self-storage properties have a widely unrecognized robust commercial customer base to complement their consumer tenants. These commercial tenants help support occupancy levels and lengthened rental terms. Approximately 25 percent of all self-storage space is rented by businesses, according to Prudential Real Estate Investors’ “The U.S. Self Storage Market” March 2005 report. Counterbalancing these strengths is the fact that self-storage facilities can be built quickly and cheaply, opening the door to oversupply.

Self-storage facilities’ cash flow diversity is also a plus. Their revenues are inherently diversified by tenant and facility—especially for the REITs, which are the larger owners. In this respect, self-storage is similar to the apartment sector, where tenant diversity is also a strength. Like the apartment sector, self-storage REITs benefit from the demographic trend of baby boomers reaching the empty nester phase and moving from large single-family residences to smaller condos or rental units. Employment growth and immigration should create momentum in the population and cause discretionary incomes to rise, creating more need for self-storage units.

Self-storage facilities offer monthly leases, so when market demand rises, they can raise rents at a faster pace than office, apartment, industrial or retail REITs, which typically have longer lease structures.

While the reverse is also true, equity investors have been reaping the benefits of the strong economy—the self-storage sector posted total returns of 38 percent in 2003 and 30 percent in 2004, keeping pace with equity REITs as a whole, which delivered returns of 37 percent in 2003 and 32 percent in 2004. As of Aug. 1, the five self-storage REITs combined to post a total return of 19 percent so far in 2005 while equity REITs overall were up 14 percent, according to NAREIT data. The only other REIT sector that has done better year-to-date are regional malls.

While a self-storage REIT’s geographic diversification is an important creditworthiness characteristic, equally, if not more, important is the REIT’s leadership in a particular market, with leadership in multiple markets being a particularly positive characteristic. Moody’s refers to this attribute as “diversity with depth.” Facility diversity, in and of itself, can even be a drawback: to the extent a firm has, say, 50 facilities scattered across the nation, it will struggle with developing market traction or cost savings. With market leadership, however, there are multiple opportunities to reduce unit costs, improve marketing and advertising power and assist in migrating tenants from high occupancy facilities to nearby ones with lower occupancy. This is similar to the strategies of hotel operators under the same flag.

Price/FFO Multiples

Source: SNL Financial. Data as of Sept. 20, 2005.

How Do Self-Storage REITs Differentiate Themselves?

REITs, with their size, diversity, frequency of local market leadership and broader access to capital, have certain advantages over local operators.

• Marketing and branding: The self-storage business is one of the few real estate sectors where a brand name can be established and cultivated. Moody’s views establishing a national brand name—with its brand awareness and pricing strengths—as one of the keys to long-term success and high ratings for a self-storage REIT.

• Operational acumen: Operators with solid infrastructure and customer service functions have a distinct competitive edge—a reflection of self-storage’s operating company characteristics. An example of best practices among REITs is having a 24-hour call center that allows for centralized customer service and leasing. Owners with only a few properties have difficulty achieving this.

• Diversification and national presence: Operators with geographically diversified portfolios (and particularly leadership in local markets) provide more comfort to investors by generating more stable cash flows, which reduces cost of capital. When one region experiences a decline, another may be exhibiting a positive trend, thus attenuating the negative effects of portfolio losses stemming from the first region.

• Location and quality of facilities: Self-storage operators with facilities that are highly visible to key traffic corridors, are located in more in-fill spots in difficult-to-build regions and are easily accessible have a competitive advantage. Some facilities also enjoy opportunities for sale into higher-and-better-use markets, an aspect of self-storage not well appreciated by some investors. As to quality, facilities with temperature controls, modern security (such as closed circuit cameras and alarms on individual units) and good maintenance are important.

• Providing ancillary products and services to customers: Another differentiating factor is the menu of storage products and services being offered at the self-storage facilities, and the effectiveness of a self-storage operator in selling such products, which include packing materials, truck rental and even leveraging the location by offering long-term parking spaces for recreational vehicles or boats in a secure, accessible location.

Self-Storage
# of REITs	5
Market Cap. (in thousands)	$13,257,384
Industry Market Cap. (in thousands)	$330,873,145
% of industry	4.0%
Yield	3.6%
YTD Total Return	24.3%
One-Year Return	40.3%
Three-Year Return	31.3%
Five-Year Return	27.3%
Average Daily Trading Volume (Shares)	1,333,319
Source: NAREIT. Data as of Sept. 30, 2005

Leading Players

Public Storage, Inc. (NYSE: PSA), the largest self-storage company in North America, has distinguished itself by creating a solid operational infrastructure. Public Storage’s national telephone reservation center, and its extensive advertising and marketing programs help it to optimize the utilization of available space and to set rental rates efficiently. Public Storage made an unsolicited takeover offer in August to acquire Shurgard Storage Centers, Inc. (NYSE: SHU), the second-largest self-storage REIT. If consummated, which seems unlikely due to the adamant claims by Shurgard officials that the company is not for sale, this merger would give Public Storage an even greater dominance in the sector. Also in August, Public Storage became the ninth REIT added to the Standard & Poor’s 500 Index.

Shurgard Storage Centers has made itself an attractive acquisition target in part because of its European network of 140 self-storage properties. Shurgard is a leader in exporting property sector expertise into undeveloped markets.

Sovran Self Storage, Inc. (NYSE: SSS) expects to continue implementation of its Dri-guard (the company’s state-of-the-art dehumidification system) and Uncle Bob’s Rental Truck initiatives, as well as convert up to an additional 250,000 to 300,000 square feet to premium (climate and humidity controlled) space.

Extra Storage Space, Inc. (NYSE: EXR) and its joint venture partner Prudential Real Estate Investors recently purchased the approximately 480-center Storage USA portfolio from GE Commercial Finance, making it a bigger player in the sector.

U-Store-It (NYSE: YSI) was formed in July 2004 after the purchase of New York Common Retirement Funds’ 72 percent interest in its predecessor company. At its IPO in October 2004, U-Store-It held 202 properties. After acquiring National Self-Storage in July 2005, the company now owns 309 facilities in 25 states.

As self-storage REITs grow, their public market penetration and acceptance by institutional investors has increased. The IPO of two new companies in the past year—Extra Space Storage and U-Store-It—has added breadth to the sector. Institutional investors are drawn to the sector’s diversification by location, tenant and property, characteristics that distinguish it from other property sectors. As the self-storage REIT sector continues to expand, it should achieve enhanced ability to tap the public markets for more equity and debt capital, thus reaching more investors.