Inflation, the general increase in prices and fall in the purchasing value of money, has wide-ranging effects on various sectors of the economy. For investors, understanding how inflation impacts their portfolio is crucial. However, certain asset classes, like self-storage facilities, exhibit unique characteristics that not only shield them from inflation's adverse effects but also offer avenues for growth. Let's delve deeper into these dynamics.
Inflation and Real Assets
Real assets, like real estate, often hedge against inflation. As the cost of goods and services rises, so does the value of tangible assets. Here's how this principle applies to self-storage facilities:
Asset Appreciation:
Historically, real estate properties, including self-storage facilities, have seen an appreciation in value during inflationary periods. This appreciation can offset the diminishing purchasing power of money, providing investors with gains in real terms.
Furthermore, while the asset's value increases, its debt remains constant. Over time, as the actual value of debt diminishes due to inflation, investors effectively see an increase in equity and returns. Together with operational improvements, increases in rent, and capital upgrades, this can lead to a substantial gain in the net profit and value of self-storage assets over time.
Rental Rate Flexibility:
Whereas many commercial real estate asset classes have very long fixed leases, one of the advantages of self-storage investments is the short-term nature of leases. Most self-storage rentals operate on a month-to-month basis, and over 70% of renters are on autopay. This allows owners to adjust rental rates in response to inflation, ensuring revenues keep pace with rising costs.
Operational Costs and Inflation
While the revenue side of self-storage investments can benefit from inflation, it's essential to consider the cost side.
Construction and Development:
Inflation can increase the cost of materials and labor. For new self-storage developments or expansions, this could mean higher initial investment costs. However, once operational, these costs stabilize, and the facility can benefit from increased rental rates. Even with the increased cost of self-storage development during COVID-19, developers are able to deliver brand-new product at costs far below what an old facility would cost to buy - giving them an edge in the marketplace.
Operational Expenses:
While some operational costs, like utilities or property maintenance, might rise with inflation, the overall operating expense ratio for self-storage facilities remains relatively low, typically between 25%-40%. This lean operational model ensures profitability even amidst inflationary pressures.
Demand Dynamics in Inflationary Periods
Inflation might lead to economic uncertainties, prompting businesses and individuals to downsize or reevaluate their space needs. This can result in increased demand for storage solutions as people and businesses seek flexible and cost-effective options to store their belongings or inventory. Businesses might look for cost-effective operational spaces. Self-storage units can serve as temporary inventory storage, workspace, or even pop-up retail spaces, further driving demand.
Conclusion
Inflation presents both challenges and opportunities for self-storage investments. While there are cost implications to consider, the inherent flexibility and demand dynamics of the self-storage sector position it favorably in inflationary environments. For investors seeking assets that can navigate and potentially benefit from inflation, self-storage facilities emerge as a compelling option.