A friend is between jobs. He works on a contract basis, moving across cities as needed, and a Sydney self-storage facility is the closest thing he has to a permanent base.

Another friend lives in a rental property. She uses a self-storage facility to hold furniture that won’t fit in her tiny apartment. As she moves from one rental to the next, the rented self-storage facility is a permanent base for goods she does not want to cart between properties.

These and other anecdotes got me thinking about the potential of self-storage property and how this asset class sits at the intersection of some powerful trends. Also, whether it is time to revisit self-storage real estate investment trusts (REITs).

Unlike the US, Australia has few self-storage REITs. The best known on ASX is National Storage REIT (NSR), and Abacus Property Group (ABP) is rapidly transitioning to this sector.

I have written favourably on National Storage for the Switzer Report several times over the past five years, nominating it as a favoured niche REIT. National Storage’s five-year annualised total return (including distributions) is almost 14%. The REIT is a good operator but looks fully valued at the current price.

Chart 1: National Storage REIT

Source: ASX

I had not previously looked at Abacus for this Report, principally because it had speculative property developments, including significant commercial property investments. But Abacus’s recent move into the fragmented self-storage market is smart and makes it an REIT to watch.

My interest in National Storage when it floated on ASX in late 2013 was based on population growth and capital city densification: as more people lived in CBD apartments and their size shrunk, demand for extra space in self-storage would rise.

Australia’s self-storage property market was highly fragmented and still is. There were a few big companies in the market and hundreds of small operators that owned one or two self-storage facilities and lacked scale to compete. National Storage had a first-mover advantage because it raised capital via an initial public offering (IPO) and more again as a listed company.

I never considered the effect of the Gig Economy, where people work in jobs on a contract basis, or the implications of the “renter generation” on self-storage demand. There is a lot more to the self-storage trend than apartment owners needing extra space for storage.

Consider the Gig Economy. An increasingly fluid labour market must support demand for self-storage. As younger people move between cities – and even countries – for short-term project work, they need a permanent base to store their goods. That used to be mum and dad’s house, but as they downsize or rent there is less scope to store goods with older parents.

Then there’s the almost one in three Australians who rent rather than own a property, a figure that continues to grow because of poor housing affordability. As people move between rental properties, some need extra self-storage space to house excess goods.

These trends partly explain growing interest in self-storage for niche REITs. In-demand facilities provide steady, recurring income for their owners. Many people have the same self-storage facility for years, possibly because it’s a pain to clear it out and move goods.

The best self-storage facilities are hard or costly to replicate. Buying or building a storage warehouse in inner Sydney, Melbourne or Brisbane is a huge ask for new entrants to the self-storage industry. Existing owners might find the big gains come not from renting self-storage but from converting it into residential or other property developments in coming years, such will be the premium on warehouse-style properties in or near a CBD.

The market, of course, is aware of these trends. Neither National Storage nor Abacus Property Group are cheap. But investors have a habit of underestimating the duration of megatrends and losing interest in companies leveraged to them once the larger, early gains are made. Longer term, that could be the case with National Storage and Abacus.

Short term, my main concern is the residential property slowdown. As falling property prices dissuade vendors from selling and properties stay on the market for longer, demand for self-storage appears to be moderating slightly, judging by National Storage’s latest result. Homeowners often rent self-storage units as they move between houses.

Moreover, lower property prices discourage home owners from renovating. A large renovation is often a trigger to move to rental and use self-storage to hold excess furniture.

However, with signs of moderation in the property downturn, this headwind for self-storage should ease in the next year. Still, the threat is worth watching because it could lower occupancy rates and yields as self-storage operators discount prices to attract business.

Abacus Property Group

Abacus looks the more interesting REIT at current valuations. The mid-cap REIT is not a pure play on self-storage: about 30% of its assets are held in storage facilities, 35% in offices and the rest in super-convenience retail properties and industrial warehouses.

In 2018, following management changes, Abacus began its transition from speculative property developments to a traditional REIT portfolio. More capital is being rotated from riskier property projects to the steadier self-storage sector.

I like the strategy and its implementation. In the next few years, Abacus should become a more stable, annuity-like business with an asset-backed business model and slowly rising distributions. Speculative property development has its place, but I prefer REITs with a mix of reliable income and steady capital growth.

Abacus is growing quickly in self-storage. It acquired a 25 per cent stake in Storage King, a top-three player in the market, and completed $54 million of self-storage acquisitions in the first half of FY19. Another $36 million of acquisitions were made after that reporting period.

Abacus has identified $40 million of self-storage acquisitions that will deliver more than 30,000 square metres of space. In addition, Abacus wants to add 15,000 square metres through expansions at more than 20 of its sites in the next few years.

The REIT anticipates a return on capital invested in self-storage of over 9%. As it buys more properties, economies of scale will grow and its average 7% yield on self-storage across the portfolio should edge higher.

An occupancy rate of 89% on an average lease of 42 months suggests Abacus has a solid portfolio of self-storage facilities and potential for modest growth in revenue per available square metre (RevPAM). Abacus’s lower funding costs relative to small players has it well positioned to compete for assets and achieve a return above its cost of capital.

An average unit price target of $3.73, based on the consensus of three broking firms that cover Abacus (a sample too small to rely on) suggests Abacus is fully valued at the current price of $3.67. Morningstar values Abacus at $3.85 a unit.

It is hard to find a re-rating catalyst in the near term: a modest valuation uplift in Abacus’s portfolio – evident in its latest interim report – is likely given the state of property markets and amid signs of greater discounting in the self-storage market and easing occupancy rates.

Abacus’s expected yield of 5.2%, based on consensus forecasts, should comfort investors while they wait for stronger conditions in the self-storage market. Abacus should slowly grow its distribution as it moves towards a more annuity-like business model.

I suspect the Abacus story is as much a micro as a macro one. CEO Steven Sewell, the former boss of Federation Centres, is well known in the REIT market and has a reputation as a deal-maker. Early signs at Abacus are encouraging and I have noticed a few more brokers starting to talk about it.

Longer term, self-storage property assets appeal. The reality is millions more Australians will need extra space as they live in increasingly smaller properties, and as many more renters are priced out of properties or more people regularly move locations for work.

However, as niche REITs, self-storage operators have higher risk that larger REITs with prime commercial, retail or industrial properties. The $2.1-billion Abacus offers diversification with its asset mix, but its outlook will be influenced heavily by the transition to self-storage.

Either way, Abacus deserves a spot on portfolio watchlists and would look interesting around $3.50, a point of previous price support on its chart. With the Australian share market ripe for a pullback, the opportunity might come in the next few months. 

Chart 2: Abacus Property Group

Source: ASX