Advice for Making Self-Storage Acquisitions in a Pandemic Environment

Here is a copy of the article Michael Pogoda published at Inside Self Storage.

The process of buying self-storage assets has changed during the coronavirus pandemic. Learn to navigate the various obstacles and get deals done from the vice president of Pogoda Cos., which managed to increase its portfolio by 11 facilities from March to October.

The coronavirus pandemic has created a ripple effect across the business world. Self-storage hasn’t been as negatively impacted as other real estate classes, but the landscape in which assets are bought and sold has indeed changed.

Here at Pogoda Cos., we’ve thus far effectively navigated the shifting conditions. In fact, we took advantage of opportunities to increase our owned and managed portfolio by 11 facilities from March to October. Following is our advice on how to get self-storage deals done in this unprecedented environment.

Be Patient and Prepared to Pivot

One of our acquisitions this year was a six-property portfolio in Michigan. The purchase went under contract early in the year and probably would’ve closed by May if not for COVID-19. Instead, the deal faced several close calls before it finally closed in September. The government-mandated stay-at-home orders issued in the spring made the due-diligence process especially difficult, and we were forced to lengthen the period. In addition, the lender requirements changed drastically.

There were also extraordinary tenant challenges. Many customers couldn’t pay, and delinquencies at these six properties skyrocketed. For legal and moral reasons, the operator couldn’t auction off any of their goods, and it clearly wasn’t a time for rent increases. In the end, getting the deal done took some pretty complex contract negotiations.

Take a Macro View

As simple as it sounds, the most important factor in evaluating a self-storage acquisition, during the pandemic or in the future, is whether the deal can stand on its own. At Pogoda, we tend to be conservative in our approach and view acquisitions in the same way we do a Qualified Opportunity Zone or 1031-exchange transaction. We don’t lean on future tax incentives; the deal has to stand on its own merits.

That said, we do analyze each purchase as a five, seven- or 10-year investment and try not to be a prisoner of the moment. Rather, we take a macro view of the property and how it should perform in the long run. If it meets our investment criteria, we buy it, COVID notwithstanding.

Really Understand the Market

The additional due diligence now required to transact goes far beyond previous closing requirements. Surveys, title, and environmental and property-condition reports are still a staple; but as a self-storage buyer, you now need to understand your consumers more than ever. As part of the new norm, you need to comprehend population-migration patterns and determine if they’re temporary or permanent. For example, are people moving from crowded cities to smaller locales? What other shifts do you see in tenant preferences? Before purchasing, you must carefully evaluate the market.

Self-storage requires a local expertise. Each market is unique due to its rural vs. urban elements, population trends, traffic and growth patterns. What we’ve incorporated into our due diligence process at Pogoda is additional analysis of main economic drivers, and whether those are strong and diverse enough to mitigate a continued pandemic or eventual recession. Communities that rely heavily on a single industry or company present a heavy risk. We’ve found it helps to diversify across multiple markets.

Be Prepared for Intensified Financial Requirements

Throughout the pandemic, lenders have drastically tightened their underwriting requirements, perceiving the market as being considerably riskier, which it is. In many acquisitions, they’ve required much higher debt-service coverage ratios and capital reserves on stabilized assets than what many of us in the industry consider to be the norm—sometimes as much as 50 percent higher.

Perhaps one of the greatest changes for today’s borrower is the need for substantial debt and real estate tax reserves. In our six-property acquisition, for example, the average debt quote required six to 12 months of mortgage reserves and six to nine months of escrow for real estate taxes. This increase in requirements has made it difficult for many local banks and commercial mortgage-backed securities to compete, leaving borrowers to look for alternative lenders. It’s also causing borrowers to consider lower loan-to-value amounts and raise additional equity to overcome lender hurdles.

Raising equity hasn’t changed quite as dramatically as debt, but there’s been a substantial shift in what investors are willing to pursue. Right now, self-storage is favored by institutional investors and private-equity firms as they shift, almost exclusively, to what they perceive as a relatively secure asset class. For cash-flowing, stable assets, we’ve found equity partners are looking for a 12 percent to 15 percent levered internal rate of return, somewhat higher than the norm before the pandemic.

What has drastically shifted is the appetite for riskier deals, such as development, lease-up, value-add and Certificate of Occupancy. For these less-stable transactions, investors (like lenders) have shown themselves to be wary. They’re either opting out of deploying capital altogether or requiring significantly higher returns to justify the unprecedented murkiness of the coronavirus world.

Like contactless food delivery and Zoom meetings, some of the recent changes to self-storage deal-making may be here to stay; but many will burn off once the pandemic is over. As seen in every recession, it’s common for lenders to tighten requirements amid uncertainty, and then gradually loosen them as the market heats up and they must compete for business. In the short term, they’ll continue to be more stringent with borrowers.

Don’t Expect a Price Break

While many buyers are looking for a price concession because of the pandemic, self-storage has proven its resiliency in tough times and sellers understand their leverage. Facility pricing has held steady. Sellers aren’t yet willing to concede on price, even if they’re willing to give leeway on other deal points.

Because of this, buyers need to do their homework more than ever. You must be comfortable that your acquisition will be able to stand up in today’s tumultuous environment. More important, it must meet your risk requirements over the next five to 10 years.