Now that the effects of the credit crisis have become more fully evident while continuing to grip our economy, 2009 has revealed a repositioning within the real estate markets. Commercial real estate values are returning to the core fundamentals that always drove the market prior to the rise of Commercial Mortgage Backed Securities (CMBS). The availability of easy, non-recourse money and the flood of investors transitioning away from Wall Street in the late 1990s led to an unprecedented spike in demand, which caused a dramatic increase in prices and a loosening of investment standards. The results have been painfully evident.

The last couple of years have represented a time in which markets stagnated, not solely due to the lack of available capital, but also due to the gap in expectations between buyers and sellers. Sellers clung to memories of historically low capitalization rates and aggressive rent projections, while buyers assumed the worst in their cash flow analysis and disregarded cap rates altogether. The chasm between buyers and sellers over the last couple of years has widened to the point of stunting almost all activity in the market. The result of the stagnation is that market values are relatively vague across most property types. However, in the self storage industry, this separation of value between buyers/sellers is not as pronounced as other property types. However, due to the lack of capital, capitalization rates for self storage facilities have increased 100 to 150 basis points over the last 12-18 months, with typical rates ranging from 8.0% to 10%. Transactions sub 8.0% are hard to find in this economy.

Most industry experts concur – the commercial real estate market trails residential and is affected by all of the additional external influences that affect the economy as a whole. When combined with the still-compounding effects of stock market fluctuations, increasing unemployment rates, decreased consumer spending (although some moderate, recent gains), and ongoing corporate restructuring and downsizing, conditions are likely to worsen in the near future. As just one more reminder, key markets such as New York are just beginning to feel the impacts of financial sector lay-offs with commercial space inventories dramatically increasing and residential foreclosures accelerating. These key markets set trends across other areas of the nation. In addition, one should be mindful still of the $3 trillion of commercial market debt coming due with no real sense of how this will be absorbed. Negative impacts could be substantial without a plan and available capital.

In addition, as financial institutions continue to flounder or be seized by the FDIC, related asset workouts are the growing trends. In the past, the FDIC would typically take over one bank in a time span covering years. In 2009, the FDIC has seized over 100 banks to date and the number is anticipated to rise rapidly. Sitting on the books of these failed financial institutions are portfolios of properties that must be immediately appraised for true, current value and factored against the current market conditions in order to dispose of the assets. While perhaps not directly deepening our economic crisis, this will most likely extend the overall recovery cycle with commercial real estate looking at another 5-7 year window for more healthy conditions.

With all of these factors in play, expect market participants in the future to be more realistic in their internal underwriting, but to place emphasis on initial cash-on-cash returns and a flight to quality. Well-located, good quality product will slowly begin to move again as the expectations between buyers and sellers move toward each other.

Jeffrey R. Shouse, PGP Valuation Inc

Self Storage Director