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Why are capitalisation rates not softening in self storage?

07/11/2023

As we wrap up the financial reporting season for 2022/2023, minimal capitalisation movement was reported by the two self storage Real Estate Investment Trusts (REITs), National Storage REIT (NSR) and Abacus Storage King (ASK). This follows 12 increases to the official cash rate by the Reserve Bank of Australia and the Reserve Bank of New Zealand. The Australian cash rate has been lifted from 0.10% in May 2022 to 4.10%, whilst the New Zealand rate shifted from 0.25% in October 2021 to 5.50% as of September 2023.

Self-Storage-Graph

A capitalisation rate (or cap rate) is the rate of return on an investment. It is calculated by dividing net operating income by the asset’s value/price. In valuations, it determines the asset's value as an inverse multiple of net income. At the high level, real estate investors expect the rate of return on their investment to demonstrate a premium to the risk-free rate – i.e., the official cash rate. A higher return demonstrates a greater spread from the risk-free rate. Assets in strong demand will often sell on lower cap rates, with the basic principle of investing suggesting that these assets have lower risk profiles. In simplistic terms, the spread between the asset’s cap rate from the risk-free rate represents the asset’s perceived level of risk. 

Both self storage investment vehicles experienced less movement to the reported weighted average capitalisation rate than REITs weighted towards traditional asset classes, such as Goodman Group (GMG) -50 basis points; Centuria Capital Group (CNI) -107 basis points; Dexus (DXS) -47 basis points; GPT Group (GPT) -25 basis points; Charter Hall (CHC) -39 basis points; Scentre Group (SCG) -26 basis points; and Vicinity Centres (VCX) -17 basis points over the 2022/2023 Financial Year.

The weighted average capitalisation rate movement was a mere -5 basis points for National Storage REIT (NSR) and only -12 basis points for Abacus Property Group / Abacus Storage King (APG / ASK). 

In a rising cost of debt environment, it is expected that returns need to increase to cover the higher cost of investing. So why is self storage resisting the pressure of interest rate rises?

  1. Increased investor appetite and a lack of opportunities 
    The self storage investment market is no longer a two-horse race between the two self storage REITs. Since 2019, we have witnessed two major overseas investors enter our market and significantly increased demand from local major and second tier owners. The market became highly competitive across the second half of 2020 and 2021. Record transaction volumes set new benchmarks for acceptable rates of return (cap rates), particularly in core capital city markets. Two things have occurred due to the increased activity in 2020/2021: 1) assets that were available for acquisition were snapped up, and 2) investors that missed out became increasingly hungry.

  2. A competitive storage landscape
    Self storage has become a target asset class for many new and emerging investors. Simultaneously, established self storage investors have strong growth strategies. Over the peak transaction period of 2020 and 2021, we observed heightened competition between major self storage investors for prime assets in core markets. We see this as established self storage investors seeking to defend their market from new entrants and protect their opportunities from one another.

  3. A wave of new capital turning to 'inflation-proof' income streams
    In addition to new entrants, we have recently observed heightened interest from major global capital funds seeking to “get a piece of the revenue pie” attracted by higher levels of return when compared to traditional asset classes. Self storage took centre stage for being a defensive asset class throughout the Pandemic, riding out the storm, and more recently, shining as an inflation-proof income stream. Much of this capital has sought to partner with existing owners, offering a means to grow and add to the active investor pool. Even at the peak of transaction activity, the sharpest (lowest) capitalisation rates in the Australasia market continue to look attractive when compared to traditional asset classes and overseas self storage markets such as the USA and Asia.

  4. Reduced upside being factored into purchaser's pricing.
    A change we have been observing is less 'upside' being factored into the price being paid for transacting assets. This relates to the adopted stabilised revenue and/or any expansion upside. With subdued revenue growth expected in the near term, major and emerging investors are reluctant to factor in uncertain upside, particularly in secondary markets, or for secondary assets. Investors may apply the same or similar cap rate to what has been achieved in the past, but noticeably, the variance we observe is in the adopted stabilised revenue. This has the result of maintaining capitalisation rates but naturally reducing achieved prices.

Conclusion 

The “risk spread” between the cash and cap rates has narrowed across the property market. Whilst cap rates have been softening across most property sectors, self storage continues to show resilience in investment metrics; driven by a strong, competitive market and healthy revenue growth. 

There are many drivers of value and facets to the ever-changing investment market. No market is immune to the macro-environment. We are fortunate that the fundamentals of self storage remain healthy. 

Wherever you are in the investment cycle, seeking advice and staying informed is worth the investment. 

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