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Dear reader,
Greetings from New York, where after a long, wet winter, spring finally arrived this week. In my house, the warmer weather heralds the start of decluttering season. Goodbye trousers that are two sizes too small. Adieu bins of random plastic trinkets and toys that my kids no longer play with.
I tend to give away or donate my unwanted items. But plenty of Americans have a hard time letting go. This has been a boon for self-storage operators.
Their strong performance has been in sharp contrast to a wider commercial property sector that is struggling badly. There may even be a correlation. Demand for offices is lacklustre because more people are working from home. They have been clearing space in their dwellings for this purpose.
Self-storage operators packed in big gains during the peak of the pandemic as Americans turned bedrooms into offices Demand also came from city dwellers who needed a place to stash their stuff when they temporarily decamped to the countryside.
The share prices of Public Storage, Extra Space Storage, CubeSmart and Life Storage hit record highs last year. The sharp rise in interest rates has taken some of the shine off the stocks. Most self-storage companies are structured as real estate investment trusts (Reits). A higher rate environment means the relatively high dividend yields generated by Reits are less attractive.
This makes the sector ripe for consolidation. Extra struck a $12.4bn all-share deal this week to absorb smaller rival Life. It comes just two months after Life rejected an $11bn unsolicited bid from industry leader Public.
Life, which operates more than 1,100 self-storage properties, was right to hold out for a better offer. Extra’s all-stock bid values the company at $145.82 a share. That is almost $20 more than Public’s all-share offer and about a third higher than Life’s share price back in early February, before reports of Public’s approach.
The offer values Life at 31 times forward earnings, compared with the 27 times both Extra and Public are trading at.
Shareholders of Life will end up owning 35 per cent of the combined company even though it will contribute just under a third of group ebitda.
Optimism about the sector’s long-term prospects is one reason Extra felt compelled to stump up. The average self-storage occupancy rate is about 92 per cent for 2022 and is expected to hold throughout 2023. This compares with about 83 per cent for offices.
Life’s exposure to faster-growing cities such as Austin, Phoenix and Raleigh is another attraction. More than 60 per cent of its facilities are in burgeoning sunbelt states. The combination of Extra and Life would leapfrog Public to become the biggest storage company in the US, with more than 3,500 locations and more than 264mn of rentable square feet.
Self-storage is a bright spot in the troubled $5.6tn commercial real estate (CRE) loan market. Recent turmoil in the banking sector has put the spotlight on the asset class, especially the office sector.
Vacancy rates are up in 25 cities surveyed by Moody’s. In Manhattan, more than 15 per cent of office space was unoccupied at the end of 2022, compared with just 7.5 per cent at the end of 2019.
The worry is that rising vacancies, along with high interest rates are pushing down property values and cash flows. As borrowers’ equity in property shrinks, some will struggle to make debt payments. That makes refinancing and defaults likely.
This would be bad news for banks that have increased their CRE lending in recent years. Within a total of $4.4tn of income-producing CRE loans, about $1.75tn is held by institutions insured by the Federal Deposit Insurance Corporation. Of this amount, 69 per cent is held by thousands of small and medium-sized banks that make up the bulk of US lenders.
What these numbers do not show is what proportion of these banks’ CRE loan holdings are backed by office properties — and in particular, older buildings that tenants are vacating.
According to Moody’s, offices make up just $750bn of the $4.4tn in income-producing CRE loans. Apartment buildings, or so-called multi-family housing rentals, account for a bigger slice at $2tn.
This segment of CRE, like storage facilities, has proved more resilient than offices. Vacancies, at about 4.7 per cent, are near historic lows. Rent rates are forecast to grow 2 to 3 per cent this year.
To assess risks properly, investors need to get a sense of how much of a bank’s CRE holdings are offices. The big picture is that a quarter of the $730bn in CRE loans that are due to mature this year are backed by office properties. While they are not as vulnerable as subprime mortgages, they will need to be refinanced. This will create pain for borrowers and banks alike.
Enjoy the rest of your week.
Pan Kwan Yuk
Lex writer
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