As a commercial real estate, self-storage provides investors exceptional prospects for long-term development and income flow. These buildings have far lower running expenses than their multifamily equivalents, and tenants choose to remain in storage units. However, those seeking a passive investing approach have a few distinct possibilities. Therefore, do REITs or syndications make more sense when investing in self-storage units?
The residue of this essay will focus on the essential factors to consider when investing in self-storage buildings through REITs and syndications. Specifically, the following themes will be discussed:
- The Advantages of Self-Storage Investment
- Investing in Self-Storage: REITs
- Investing in Self-Storage: Syndications
- Final Reflections
The Advantages of Self-Storage Investment
Self-storage offers the following benefits to investors who are weighing their commercial real estate options:
Comparatively Low Operating Expenses
Frequently, passive real estate investors concentrate on multifamily properties. Most individuals have lived in an apartment complex at some time; thus, this asset class has intrinsic familiarity. Moreover, many novice investors feel that apartment complexes provide the highest profits since people will always need a place to live, right?
In truth, self-storage buildings have considerably lower operating expenditures per square foot than multifamily complexes. A recent study indicates that self-storage operating costs are between $2.75 and $3.50 per square foot, compared to $3.50 and $5.00 per square foot for multifamily properties. Moreover, the more extensive apartment leases do not compensate for these incredible prices. In other words, self-storage units attract a comparable rent per square foot — from $7.5 and $12 per square foot for both property categories. Consequently, self-storage buildings often provide greater average returns than multifamily properties.
Renter Inertia
People’s usual attitude to renting a storage unit is a significant benefit of investing in self-storage properties. The out-of-sight, out-of-mind occurs whenever a person spends a Saturday day transferring excess items into a storage container. Automatic payments compound this problem since renters don’t even have to think about paying rent regularly — it occurs automatically in the background.
Simply put, self-storage tenants have too much inertia to justify relocating. After occupying a storage facility, many individuals lack the drive to remove their belongings. This makes long-term tenancy quite prevalent in the self-storage market.
Nature’s Anti-Cyclical Behavior
Additionally, self-storage offers investors a robust portfolio hedge against economic downturns. The performance of several commercial property categories (such as offices, retail, and industrials) mirrors that of the overall economy. In a robust economy, they function well. In a depressed economy, performance typically deteriorates.
In contrast, self-storage facilities often exhibit counter-cyclical performance. People tend to A) return to school and B) move into smaller houses or flats during economic downturns. Both routes result in individuals having too many belongings in their new homes. Instead of discarding unwanted items, consumers frequently choose to place them in storage lockers. This generates a dynamic in which self-storage demand grows as the economy deteriorates. This fact makes self-storage units a good anti-cyclical hedge for a portfolio.
Population Trends
Although discussing the impact of demographic trends on self-storage demand over the next many decades is morbid, investors cannot ignore them. In 2020, the younger generation surpassed the baby boomers as the largest living adult generation in the United States.
As baby boomers die away over the next 30+ years, their children will be faced with the emotionally taxing process of selecting what to do with their parents’ belongings. Instead of confronting the agony of sorting and discarding these objects, many youngsters will settle for storing them. This solution spares children the sorrow of disposing of their parents’ belongings, and it will raise demand for self-storage facilities for the foreseeable future.
Having established the benefits of self-storage as an asset class, we will now investigate the following question: self-storage REITs or syndication? By analyzing the benefits and drawbacks of both alternatives, investors can choose the line of treatment that provides the most value given their particular economic position.
Investing in Self-Storage: REITs
Self-Storage REIT Overview
Real estate investment trusts (REITs) are a financially attractive alternative for inactive property investors. Parallel to purchasing stocks, investors get the business itself, not the underlying assets, when they buy REIT shares. The REIT runs the underlying properties and distributes a significant percentage of its earnings to investors.
In addition, most REITs specialize in a specific real estate specialty. Consequently, investors may acquire shares in self-storage REITs, exposing them to the property type without the requirement to operate and run a storage facility.
REIT Self-Storage Investment Advantages
- Legally, REITs are required to distribute at least 90 percent of their taxable revenue as dividends. Self-storage REITs combine the property mentioned above type benefits with a continuous stream of prizes that are often much bigger than mutual funds or individual equities.
- High liquidity: several REITs are publicly traded. This makes self-storage REIT shares far more liquid than most other real estate assets. REITs expose self-storage to investors who cannot afford to lock up a substantial amount of cash in an illiquid asset while being very liquid. These shares may be purchased and sold similarly to other publicly traded stocks and ETFs.
Cons of Self-Storage REIT Investments
- Unfortunately, the IRS does not consider most REIT dividends “qualified.” Most of these payouts are thus subject to ordinary income tax rates rather than the more advantageous long-term capital gains tax rates. This may result in a 37 percent federal tax for high-income investors instead of the 15 percent or 20 percent rate paid to qualified dividends. As a result of this tax treatment, having self-storage REITs in a tax-deferred retirement plan is a fantastic tax strategy.
- Self-storage REITs that are publicly listed are very sensitive to interest rate fluctuations. While the value of all commercial real estate remains susceptible to changes in interest rates, the value of REITs fluctuates far more than the value of the underlying assets. In general, when interest rates increase, REIT values decrease. This may not be a concern for investors whose main objective is to generate fixed income. However, REITs may be relatively volatile if they are focused on capital preservation.
Investing in Self-Storage: Syndications
Overview of Self-Storage Syndication
Multiple investors might combine their funds via real estate syndications in pursuit of a transaction. A deal sponsor (or general partner) typically identifies, arranges, and executes a transaction before overseeing its daily operations. In addition, several investors (or limited partners) give the required funds to make the transaction possible. Consequently, the sponsor may proceed with the transaction, and the investors will acquire an ownership position in a property governed by a third party.
Consider the cost of a self-storage facility: $2,000,000. A single investor would likely require a 20 percent down payment, or $400,000, to acquire it. Alternately, a deal sponsor might contribute a portion of the down payment and construct syndication in which investors contribute the remainder. If an investor provides $100,000 toward this $400,000 minimum, he or she will obtain a 25% share in the transaction.
Advantages of Investing in Self-Storage Syndications
- Self-storage syndications do not seem to provide a more advantageous tax status than REITs since investors must pay ordinary income tax rates on any rental revenue received. Syndication investors get proportional shares of all payments and costs owing to their direct ownership of a piece of the underlying property. Depreciation is passed down to investors, usually resulting in a taxable loss despite a positive cash flow.
- Returns: Syndications invest in individual transactions. Consequently, performance might vary widely from transaction to marketing. In general, however, investing in a self-storage syndicate will provide higher profits than investing the same amount of cash in a self-storage REIT, mainly when the abovementioned tax is included.
Cons of Investing in Self-Storage Syndications
- As noted, investors in self-storage syndications immediately own a portion of the facility, which provides liquidity. This renders these investments exceedingly illiquid since limited partnership ownership in syndication cannot be rapidly converted into cash. Instead, most syndicates have well-defined periods (e.g., 5- or 10-year deals). This implies that you get cash flows throughout the transaction and then receive a final payment upon the asset’s sale. This makes syndications unattractive for investors who cannot afford to lock up funds for a longer term.
- As publicly listed organizations, REITs are subject to a great deal of regulatory scrutiny. In contrast, syndication is subject to far less control. When investors join a syndicate, the chance of A,) fraud and B) poor investment performance increases significantly. Before participating in self-storage syndication, investors should thoroughly understand commercial real estate underwriting, emphasizing self-storage due to this risk. Ultimately, investors must screen these agreements on their own, so they should never engage them without performing extensive research.
Final Reflections
As with most financial issues, there is no definitive solution to the self-storage REIT vs. syndication debate. Instead, investors must examine their own circumstances and investing goals. REITs are generally advantageous for investors seeking fixed-income performance in a tax-favored account. In contrast, investors that want more significant returns (and are ready to bear the accompanying risk) and desire the tax advantage of pass-through depreciation might pursue syndications.
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