Q&A with SROA Capital
Editor’s note: Evercore Wealth Management supplements its core investment capabilities with carefully selected outside funds across the range of the firm’s asset classes.
Here we discuss opportunities in self-storage with Benjamin S. Macfarland III, Chief Executive Officer and Co-Founder of SROA Capital, LLC (“SROA”). SROA is a leading, vertically integrated private equity real estate and technology platform that has an established track record of providing risk-adjusted returns to its capital partners through its focused strategy of investing in self-storage throughout the United States. Evercore Wealth Management recently invested in its most recent fund, SROA Capital Fund VIII. Please note that this article represents the views of SROA and not necessarily the views of Evercore Wealth Management.
Q: Self-storage has been a huge pandemic play for investors, with returns for the asset class outstripping real estate investment trusts and the broader market by a considerable margin. Why do you think that is – and do you worry that it’s going to change as the pandemic subsides?
A: The pandemic has generated a surge in storage demand as people were dislocated for periods of time and, in many cases, have changed the way they work and live. Whether it was college kids forced off campus, young professionals moving back in with their family, professionals clearing out an extra bedroom to create space for a home office, or investment managers moving their businesses and families to Miami, people from all sorts of backgrounds found themselves in a transition.
Storage is not a new concept. It has been around since the 70s and has become a widely accepted commodity. Today, storage is utilized by both businesses and individuals, with roughly one in 10 U.S. households renting a unit. For individuals, storage serves as a short-term solution during a life event or as a long-term extension of the home. Life events creating a need for storage can be positive (relocating for a new job or building a new home) or negative – something we call the “4 D’s” – death, divorce, downsizing, and dislocation. Positive life events have a strong positive correlation with the macroeconomy, while negative life events have a strong negative correlation, creating demand during both good times and bad. For small businesses, storage functions as a critical part of the supply chain. A contractor uses storage for equipment and materials, while the owner of an e-commerce business utilizes storage for order fulfillment. During prosperous times, businesses move from the garage to a storage facility, and during bad times, as we saw with COVID-19, businesses downsize from a light industrial warehouse to a storage facility. Storage has become an integral part of the economy as more and more Americans recognize its benefits.
One of storage’s most attractive traits from an investment perspective is its ability to generate consistent growing dividends that can be sustained through down cycles. This is a major reason why storage has outperformed other asset classes, and we expect this to continue.
Q: As you say, there are a lot of storage units out there, a lot of different companies. How do people decide which to use?
A: At SROA, we are a consumer-facing business. Every day we interact with consumers who rent space to solve a problem. When you think about storage, I think it’s analogous with an emergency room – you only need it when you need it, and you’re not going to spend a lot of time shopping around. And so, the location of a facility plays an important role when acquiring customers. In fact, of the roughly 80,000 unique tenants we have at SROA, close to 75% of them live within five miles of their unit.
Now, location is always an important factor, but you need to have other ways to attract new tenants. At SROA, we have built an operational technology platform overseen by an in-house digital marketing team that focuses solely on our marketing and digital web capabilities – things like search engine optimization (organic search) and search engine marketing (pay per click) – to develop targeted customer acquisition strategies for each market and property. We also have a 30-person customer call center that fields over 10,000 calls a month. Having this infrastructure in place is a critical component of our business, and its importance was highlighted more than ever by the onset of COVID-19. Pre-COVID, roughly 65% of our customer leads were generated through digital channels, be it from a Google search or paid advertisement; at peak-COVID levels, this figure jumped to over 90%. And today, this figure has settled down around 84%; we believe it will stay in this range.
Q: Self-storage is a highly fragmented asset class that is recognized for its strong performance during the COVID pandemic. How has the competitive landscape changed within the industry, and how do you see this industry consolidating?
A: Storage was one of the best performing asset classes during the pandemic and the best performing REIT sector during the great financial crisis. During the depths of COVID, our occupancy was flat year over year, rent collections were up, and we maintained our quarterly distributions, something we have never missed since I founded SROA in 2013. Given the strong performance of the asset classes during these periods, we have seen several new entrants into the space, but most are really only focused on acquiring large, brokered portfolios (>$500mm). This has had little to no effect on our business and, in the end, they have provided us with another exit option by deepening the institutional buyer pool for large portfolios.
A few other reasons we have seen little change to the competitive landscape include the size and fragmentation of the market and our focused roll-up strategy. First on the market, Public Storage is the largest player in the space with a market cap of ~$65 billion, and they only own 5.8% of the market, which means self-storage is a ~$1.1 trillion market. The top 100 operators only own ~29% of the market; the remainder is owned by non-institutional (or “mom and pop”) owners. We see this landscape evolving over the next five to ten years as these mom and pop owners approach retirement age and look to sell their assets. The largest group of these owners is the Baby Boomer generation who lack succession and estate planning. Let’s face it, storage is a not a sexy business, and more times than not the second generation would rather sell the business than assume operations. That’s where we come in. Our focus has always been on acquiring regional operators to expand our footprint into new markets and to then send our dedicated in-house acquisitions team into these new markets to acquire smaller independent storage operators. To date, this strategy has served us well, as 81% of our acquisitions have been sourced off market.
Q: What do you think about current market conditions, notably the increasing volatility and the prospect of inflation?
A: Volatility in markets creates opportunities, and we have been a direct beneficiary of the public market volatility created by COVID. The first acquisition in the SROA Capital Fund VIII was a 16-property portfolio in southern New England (Connecticut, Massachusetts, Rhode Island) that came about when a large public REIT was forced to drop the deal when their stock sold off ~30% in April of 2020. This was a portfolio that we had bid on but were ultimately outbid by the REIT. When we heard that the REIT had dropped the deal, we immediately called the seller and were able to negotiate the purchase on a direct basis without it ever going back to market. This portfolio has been the best performer in the fund. We have already acquired two additional properties in New England and are looking to expand our footprint in this region.
As for inflation, we welcome it and view it as a tailwind to our business, but we do not want to see hyperinflation. There are few asset classes better suited for an inflationary environment than storage, as all our tenants are on month-to-month leases, which allows us to raise rents with 30 days’ notice. People who are not familiar with the asset class often view these month-to-month leases as a liability, but our average length of stay is ~14 months, which is longer than multifamily and, more important, provides us with real pricing power to protect against inflation.
For further information on SROA and the other externally managed funds on the Evercore Wealth Management platform, please contact Partner and Portfolio Manager Stephanie Hackett at email@example.com.
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